To qualify for hedge accounting under IFRS 9, a hedging relationship must meet three core conditions. It must consist only of eligible hedging instruments and eligible hedged items; it must be formally designated and documented at inception; and it must meet IFRS 9’s hedge effectiveness requirements. These effectiveness requirements include demonstrating an economic relationship between the hedged item and the hedging instrument, ensuring that credit risk does not dominate the resulting value changes, and using a hedge ratio that reflects the quantities actually used for risk management.
IFRS 9 replaced the rigid 80–125% effectiveness threshold applied under IAS 39 with a more principles-based approach designed to align hedge accounting more closely with actual risk management.
The sections below explain each qualifying condition, from eligible hedging instruments and hedged items through to documentation, hedge effectiveness testing, rebalancing and the circumstances that end a hedging relationship.
What are the three qualifying criteria for hedge accounting under IFRS 9?
Under IFRS 9, a hedging relationship qualifies for hedge accounting when three broad conditions are met:
- The relationship consists only of eligible hedging instruments and eligible hedged items.
- The hedging relationship and the entity’s risk management objective and strategy are formally designated and documented at inception.
- The relationship meets IFRS 9’s hedge effectiveness requirements.
The hedge effectiveness requirements have three elements: there must be an economic relationship between the hedged item and the hedging instrument; credit risk must not dominate the value changes arising from that relationship; and the hedge ratio must reflect the quantities actually used for risk management.
Formal designation and documentation require the entity to identify the hedging relationship, its risk management objective and its strategy before applying hedge accounting. This is not a retrospective exercise. The documentation should specify the hedged item, the hedging instrument, the nature of the hedged risk and how hedge effectiveness will be assessed.
An economic relationship exists when the hedged item and hedging instrument respond to the same risk in a way that results in offsetting value changes. IFRS 9 does not require a perfect offset, but the relationship must reflect an economically meaningful risk management relationship.
Credit risk must not dominate the value changes resulting from the relationship. In other words, even where the economics of the underlying hedge are aligned, changes driven primarily by counterparty or own credit risk could prevent the hedge from meeting the effectiveness requirements.
Finally, the hedge ratio used for hedge accounting should generally reflect the quantities of the hedged item and hedging instrument that the entity actually uses for risk management. It should not be deliberately adjusted to achieve a particular accounting result.
These requirements must continue to be met throughout the life of the designated hedging relationship.
What counts as an eligible hedging instrument under IFRS 9?
Eligible hedging instruments under IFRS 9 include derivatives measured at fair value through profit or loss, subject to specific exceptions, as well as certain non-derivative financial instruments measured at fair value through profit or loss.
Derivatives are the most common hedging instruments in banking. Interest rate swaps, cross-currency swaps, forward contracts and purchased options may all qualify when the IFRS 9 requirements are met. For hedge accounting in consolidated financial statements, the hedging instrument must generally involve a party external to the reporting entity.
IFRS 9 also permits entities to designate certain components of a financial instrument rather than necessarily designating the instrument in its entirety. For example, an entity may designate the intrinsic value of an option while excluding its time value, or designate the spot element of a forward contract while excluding the forward element.
This flexibility can help align hedge accounting more closely with the way the underlying risk is actually managed. Excluded components may be accounted for separately under IFRS 9’s cost of hedging provisions where the relevant conditions are met.
Written options are subject to restrictions and generally cannot be designated as hedging instruments unless they are used to offset a purchased option.
What items can be designated as hedged items?
Under IFRS 9, a hedged item can include a recognised asset or liability, an unrecognised firm commitment, a highly probable forecast transaction or a net investment in a foreign operation. Groups of items and certain aggregated exposures can also qualify where the relevant IFRS 9 conditions are satisfied.
For banks, common examples include fixed-rate loans or portfolios hedged against changes in benchmark interest rates, foreign-currency exposures hedged against exchange-rate movements and forecast debt issuances hedged against future interest-rate movements.
IFRS 9 also allows eligible risk components to be designated separately where they are separately identifiable and reliably measurable. In a banking context, for example, this can allow the benchmark interest rate component of an exposure to be designated instead of the entire contractual cash flow exposure.
General business risks cannot simply be designated as hedged items. The designated risk must meet the IFRS 9 requirements and be capable of affecting profit or loss or, in certain circumstances, other comprehensive income.
The eligibility of the hedged item is therefore an important part of determining whether a proposed hedging relationship can qualify for hedge accounting in the first place.
How does IFRS 9 assess hedge effectiveness?
IFRS 9 assesses hedge effectiveness by determining whether the designated relationship continues to meet three requirements: an economic relationship exists between the hedged item and the hedging instrument; credit risk does not dominate the value changes arising from that relationship; and the hedge ratio appropriately reflects the quantities used for risk management.
There is no fixed numerical effectiveness threshold comparable with the 80–125% range previously associated with IAS 39. Instead, IFRS 9 uses a principles-based assessment.
Prospective effectiveness assessment
The effectiveness assessment is forward-looking. It is performed when the hedging relationship is designated and subsequently on an ongoing basis, including at reporting dates and when relevant circumstances change.
Depending on the characteristics of the relationship, an entity may use either qualitative or quantitative assessment methods.
Where the critical terms of the hedged item and hedging instrument are closely aligned, a qualitative assessment may be appropriate. Where differences exist, quantitative analysis may be needed to demonstrate that the economic relationship continues to meet the IFRS 9 requirements.
Retrospective effectiveness and measuring ineffectiveness
IFRS 9 does not require the same separate retrospective 80–125% effectiveness test that applied under IAS 39. However, hedge ineffectiveness still has to be measured and recognised appropriately.
IFRS 9 does not prescribe a single calculation method for every hedging relationship. The approach used should reflect the characteristics of the relationship and be capable of measuring the sources and amount of hedge ineffectiveness.
For a cash flow hedge, the effective portion of gains or losses on the hedging instrument is generally recognised in other comprehensive income, subject to the IFRS 9 requirements, while hedge ineffectiveness is recognised in profit or loss.
For a fair value hedge, changes in the fair value of the hedging instrument and corresponding changes in the hedged item attributable to the designated risk are recognised in a way that results in hedge ineffectiveness being reflected in profit or loss.
It is important to distinguish hedge effectiveness testing from hedge accounting itself. Effectiveness testing determines whether and to what extent a designated hedging relationship meets the relevant requirements and measures ineffectiveness. Hedge accounting governs how the resulting amounts are recognised and presented in the financial statements.
What documentation is required to designate a hedging relationship?
To designate a hedging relationship under IFRS 9, an entity must establish formal documentation at inception. The documentation identifies the hedging relationship, the risk management objective and strategy, the hedged item, the hedging instrument, the nature of the hedged risk and how the entity will assess whether the relationship meets the hedge effectiveness requirements.
The documentation must be sufficiently specific to demonstrate how the designated relationship corresponds with the entity’s actual risk management activities. It cannot simply be prepared retrospectively after the hedge has already been established.
Where an entity excludes components such as the time value of an option or the forward element of a forward contract from the designated hedging relationship, the documentation should also establish how those components are treated.
For banks managing large numbers of hedging relationships, the operational challenge extends beyond documentation. Treasury positions, ALM exposures, cash flows, derivative valuations, hedge effectiveness testing and hedge accounting processes need to remain aligned as markets and balance sheet positions change.
This is where an integrated approach can be valuable. MORS brings Treasury and ALM data together with cash flow modelling, derivative valuation, hedge effectiveness testing and hedge accounting capabilities within the same environment. This helps banks manage hedge relationships using the same underlying positions and calculations that support their broader Treasury and balance sheet management processes.
What about macro hedge accounting under IFRS 9?
Banks should distinguish IFRS 9’s general hedge accounting model from the accounting treatment of certain macro hedging strategies.
This is particularly important for fair value hedges of the interest rate exposure of a portfolio of financial assets or financial liabilities, often referred to as fair value macro hedging. IFRS 9 retained a scope exception in this area, and entities applying IFRS 9 hedge accounting can continue to apply the relevant IAS 39 requirements for portfolio fair value hedges of interest rate risk.
This distinction matters for banks because interest rate risk is often managed at portfolio or balance sheet level rather than exclusively through one-to-one hedging relationships.
At the same time, IFRS 9 does allow hedge accounting for qualifying groups of items and certain net positions. The appropriate accounting therefore depends on the structure of the exposure, the hedging strategy and the type of designated relationship.
For banks using both micro and macro hedging approaches, it is important to understand which accounting requirements apply to each relationship. A micro hedge may establish a direct relationship between a specific exposure and hedging instrument, while macro hedging can involve managing interest rate risk across a wider portfolio of exposures.
When does a hedging relationship stop qualifying under IFRS 9?
A hedging relationship ceases to qualify for hedge accounting when it no longer meets the qualifying criteria. This may occur, for example, when the hedging instrument expires or is sold, terminated or exercised, or when the risk management objective for the relationship changes.
Unlike IAS 39, IFRS 9 does not permit an entity simply to discontinue hedge accounting voluntarily while the qualifying hedging relationship and underlying risk management objective continue to exist.
If the hedge ratio no longer appropriately reflects the relationship between the quantities of the hedged item and hedging instrument, but the risk management objective remains unchanged, the entity may need to rebalance the hedging relationship rather than discontinue it.
Rebalancing involves adjusting the quantities designated in the hedging relationship so that the hedge ratio once again satisfies the IFRS 9 requirements. This allows hedge accounting to continue where the underlying risk management relationship remains in place.
When a hedging relationship does end, the accounting treatment depends on the type of hedge and the reason for discontinuation. For a cash flow hedge, amounts accumulated in the cash flow hedge reserve may remain there until the forecast transaction affects profit or loss. If the forecast transaction is no longer expected to occur, the accumulated amount is reclassified immediately to profit or loss.
For a fair value hedge of an interest-bearing financial instrument, the accumulated fair value hedge adjustment to the carrying amount is subsequently amortised to profit or loss in accordance with the applicable requirements.
Monitoring the ongoing eligibility of hedging relationships therefore requires consistent attention to market conditions, hedge ratios, underlying exposures and the bank’s risk management activities. Changes to the strategy, hedged item or hedging instrument can require reassessment, rebalancing or discontinuation.
For banks, this places hedge accounting within the broader context of Treasury, ALM and interest rate risk management. Connecting hedge relationships with the underlying balance sheet exposures, cash flows and derivative valuations can help maintain consistency between the bank’s risk management activities, hedge effectiveness testing and accounting treatment.