• The Board was informed that many entities that have
demandable liabilities (repayable on demand or after a notice period such as demand deposits and some types of time deposits) include them in a portfolio hedge by scheduling them to the date when they expect the total amount of demandable liabilities in the portfolio to be due because of net withdrawals from the accounts in the portfolio. This expected repayment date is
typically a period covering several years into the future. Some wish to apply FV hedge accounting based on this scheduling.
a) It is consistent with how demandable liabilities are scheduled for RM purposes.
– Interest rate RM involves hedging the interest rate margin resulting from assets and liabilities and not the FV of all or part of the assets and liabilities included in the hedged
portfolio. The interest rate margin of a specific period is subject to variability as soon as the amount of fixed rate assets in that period differs from the amount of fixed rate liabilities in that period.
b) The treatment of prepayable assets is to include demandable liabilities in a portfolio hedge based on expected repayment dates.
c) As with prepayable assets, expected maturities for
demandable liabilities are based on the historical behaviour of customers.
d) Applying the FV hedge accounting framework to a portfolio that includes demandable liabilities would not entail an
immediate gain on origination of such liabilities because all assets and liabilities enter the hedged portfolio at their
carrying amounts.
e) Historical analysis shows that a base level of a portfolio of demandable liabilities is very stable. Whilst a portion of the demandable liabilities varies with interest rates, the remaining portion, the base level, does not. Hence, entities regard this base level as a long-term fixed rate item and include it as such in the scheduling that is used for RM purposes.
f) The distinction between ‘old’ and ‘new’ money makes little sense at a portfolio level. The portfolio behaves like a long-term item even if individual liabilities do not. 185
• The Board noted that:
a)although entities may schedule demandable liabilities based on the expected repayment date of the total balance of a portfolio of accounts, the deposit liabilities included in that balance are
unlikely to be outstanding for an extended period. The balance of the portfolio is relatively stable only because withdrawals on
some accounts are offset by new deposits into others. Thus, the liability being hedged is actually the forecast replacement of existing deposits by the receipt of new deposits. IAS 39 does not permit a hedge of such a forecast transaction to qualify for FV hedge accounting.
b)a portfolio of demandable liabilities is similar to a portfolio of trade payables. Both comprise individual balances that usually are expected to be paid within a short time and replaced by new
balances.
– For both, there is an amount that is expected to be stable and present indefinitely. If the Board were to permit demandable liabilities to be included in a FV hedge on the basis of a stable base level created by expected replacements, it should
similarly allow a hedge of a portfolio of trade payables to qualify for FV hedge accounting on this basis.
c) a portfolio of similar core deposits is not different from an individual deposit, other than that, in the light of the ‘law of large numbers’, the behaviour of the portfolio is more
predictable. There are no diversification effects from aggregating many similar items.
d) it would be inconsistent with the requirement that the FV of a liability with a demand feature is not less than the amount payable on demand, discounted from the first date that the amount could be required to be paid, to schedule such liabilities for hedging purposes using a different date.
– E.g., consider a deposit of 100 that can be withdrawn on demand without penalty. The FV of such a deposit is 100, that is unaffected by interest rates and does not change when interest rates move.
Accordingly, the demand deposit cannot be included in a FV hedge of interest rate risk—there is no FV exposure to hedge. 187
• The Board also considered whether a demandable liability could be included in a portfolio hedge based on the expected repayment date of the existing balance of individual deposits, ie ignoring any rollovers or replacements.
a)For many demandable liabilities, this approach would imply a much earlier expected repayment date than is generally assumed for RM purposes. For chequing accounts it would probably imply an expected maturity of a few months or less. For fixed term
deposits that can be withdrawn only by the depositor incurring a significant penalty, it might imply an expected repayment date that is closer to that assumed for RM.
b) This approach implies that the FV of a demandable deposit liability is the PV of the amount of the deposit discounted from the expected repayment date, would give rise to a difference on initial recognition between the amount deposited and the FV recognised in the BS. and in turn, gives rise to the issue of what the difference represents.
Possibilities include (i) the value of the depositor’s option to withdraw its money before the expected maturity, (ii)
prepaid servicing costs or (iii) a gain. The Board did not reach a conclusion on what the difference represents, but agreed that if it were to require such differences to be
recognised, this would apply to all demandable liabilities, not only to those included in a portfolio hedge.
c) If the FV of a demandable deposit liability at the date of initial recognition is deemed to equal the amount deposited, a FV portfolio hedge based on an expected repayment date is unlikely to be effective. This is because such deposits
typically pay interest at a rate that is significantly lower than that being hedged. Hence, the FV of the deposit will be
significantly less sensitive to interest rate changes than that of the HI.
d) The question of how to FV a demandable liability is closely related to issues being debated by the Board in other
projects, including Insurance (phase II), Revenue Recognition, Leases and Measurement. The Board’s discussions in these other projects are continuing and it would be premature to reach a conclusion in the context of portfolio hedging without considering the implications for these other projects. 188
• Consequently, that a demandable liability cannot qualify for FV hedge accounting for any time period beyond the shortest period in which the counterparty can demand payment. 189
• Assume that in a particular repricing time period an entity has 100 of fixed rate assets and 80 of what it regards as fixed rate liabilities and the entity wishes to hedge its net exposure of 20. Assume that all of the liabilities are demandable and the time period is later than that containing the earliest date on which the items can be repaid. If the HO is designated as 20 of assets, then the demandable liabilities are not included in the HO, but rather are used only to determine how much of the assets the entity wishes to designate as being hedged. In such a case, whether the demandable liabilities can be designated as a HO in a FV hedge is irrelevant. However, if the overall net position were to be designated as the HO, because the net position comprises 100 of assets and 80 of demandable liabilities, whether the
demandable liabilities can be designated as a hedged item in a FV hedge becomes critical. 190
• The issue is still relevant if, in a particular repricing time period, the entity has so many demandable liabilities whose earliest repayment date is before that time period that (a) they comprise nearly all of what the entity regards as its fixed rate liabilities and (b) its fixed rate liabilities exceed its fixed rate assets in this repricing time period, the entity is in a net liability position and needs to designate an amount of the liabilities as the hedged item. 192
• Then the Board considered how to overcome the systems problems noted in BC176b&c. These problems arise from designating individual assets (or liabilities) as the HO.
Accordingly, the Board decided that the HO could be expressed as an amount (of assets or liabilities) rather than as individual assets or liabilities. 193
• This gives rise to the issue of how the amount designated should be specified. The Board concluded that it should require a method of
designation that closely approximates the accounting result that would be achieved by designating individual items. 194
• The Board noted that designation determines how much, if any,
ineffectiveness arises if actual repricing dates in a particular repricing time period vary from those estimated or if the estimated repricing dates are revised. 195