Interest Rate Risk Management: IASB proposes new accounting requirements when hedging net repricing risk

Background to the proposals

The IASB developed these proposals to provide enhanced transparency over interest rate management activities, particularly about the extent to which these activities have been effective or not. The new accounting model is designed to allow for greater consistency between the accounting for interest risk mitigation and the entity’s actual interest rate risk management activities.

The new risk mitigation accounting model has been developed based on banks’ interest rate management activities. However, the IASB is keen to understand whether this model could be extended to other sectors, in particular insurance.

The new risk mitigation accounting model in detail

1. Scope and eligibility

The risk mitigation accounting model may only be applied in specific situations. The business activities of the entity need to give rise to the recognition and derecognition of financial instruments that expose the entity to interest rate repricing risk and the entity mitigates that risk on a net basis using derivatives. This accounting option may therefore not be available for all interest rate management activities.

The model is optional to apply, but similarly to other hedge accounting requirements, it is subject to certain conditions. For example, an entity needs to document its risk management activities, including the risk limits that it sets for interest rate repricing risk, according to its own risk management practices. 

2. The mechanics of the model

2.1 Underlying portfolios and future transactions

The risk mitigation accounting model is applied to portfolios of assets and liabilities. Eligible items in these portfolios include financial assets and liabilities measured at amortised cost assets, financial assets measured at fair value through other comprehensive income, as well as future transactions that could result in such financial assets and liabilities. Demand deposits are eligible items, but an entity’s own equity instruments are not. ‑cost assets,

1.2  Net repricing risk exposure (NRRE)

Repricing risk is defined as interest rate risk which exposes an entity to variability of cash flows or fair value movements from financial instruments. The repricing risk arises because of differences in amount and timing when financial instruments reprice, i.e. reset the interest rate.

The NRRE is determined by aggregating exposures into repricing or maturity bands based on contractual terms and behavioural assumptions. The methodology used must correspond to internal risk management practices and is not prescribed by the accounting rules.

2.3 Risk Mitigation Objective (RMO)

The RMO is the absolute amount of net exposure to repricing risk for each maturity band, that an entity has determined should be mitigated. The RMO cannot be higher than the NRRE and it needs to be evidenced by the designated derivatives. The RMO is not a static amount but is continuously adjusted to reflect an entity’s ongoing risk management activities.

2.4 Designated derivatives

Designated derivates are all derivatives held for the purpose of managing repricing risk on a net basis in accordance with the entity’s risk management strategy. These are limited to derivatives with external parties and exclude most net written options and any derivatives already designated in other hedging relationships.

2.5 Benchmark derivatives

Benchmark derivatives have to be designed to replicate exactly the amount and timing of the repricing risk specified in the RMO. The benchmark derivatives therefore must never exceed the NRRE and must be adjusted for changes to the RMO and NRRE, if necessary. Benchmark derivatives are a key element of the model. They have a similar role as hypothetical derivatives in cash flow hedges because they are the reference point for measuring the effectiveness of the risk mitigation activities.

2.6 Risk Mitigation Adjustment (RMA)

The RMA is a new accounting concept, presented on the balance sheet as a separate item and can either be positive or negative. It is measured as the lower of (i) the cumulative fair value gains or losses on designated derivatives and (ii) cumulative changes in the fair value of the benchmark derivatives. Any excess of cumulative fair value gains or losses on the designated derivatives over the fair value changes of the benchmark derivatives, is recognised in profit or loss. The excess recognised in profit and loss reflects the ineffectiveness of the risk mitigation activities. The RMA is released to profit or loss when the repricing differences affect profit and loss. The RMA is subject to an “excess test” and must not exceed the present value of the NRRE.

3. Discontinuation

Once an entity opted to use the risk mitigation accounting model, it is not permitted to discontinue its application. However, application must discontinue when there is a change in risk management strategy, which includes, for example, the change of the mitigated benchmark interest rate. Upon discontinuation the RMA will be released to profit or loss, either immediately or over time, depending on whether the underlying portfolios are still expected to affect future profits or not.

4. Disclosures

New disclosures to explain the entity’s risk management activities for net repricing risk will need to be provided, regardless of whether the entity adopts the risk mitigation accounting model or not. Entities that apply the model will need to provide disclosures of the effect it has on current and future financial statements.

5. Other possible consequences of the proposals

The IASB is intending to withdraw IAS 39 and entities using the IAS 39 hedge accounting requirements, will need to transition and adopt the equivalent requirements in IFRS 9.

Some entities, including many building societies apply IAS 39 under UK GAAP for their financial instruments accounting. Whilst the IASB proposals do not change UK GAAP accounting requirements directly, the Financial Reporting Council (FRC) may withdraw the option to apply IAS 39 when the standard is withdrawn by the IASB. The IASB’s proposals are therefore also relevant for entities applying IAS 39 under UK GAAP, especially those that apply the IAS 39 hedge and macro-hedge accounting requirements.

Although the new risk mitigation accounting model is designed for interest rate management practices in banks, the proposals may affect entities outside financial services, for example those with significant treasury operations and exposure to net repricing risk.

Because of the complexities involved in applying the new model the IASB is seeking input from entities through field testing of the proposals and responses should be submitted by November 2026. Given this extended consultation period any new requirements are not expected to be finalised by the IASB before 2027.

What are the key takeaways around the risk mitigation model?

Interest rate risk management practices are complex, and it is a difficult task for the IASB to develop an accounting model that achieves greater transparency over the efficacy of risk management practices whilst also being practicable to implement. We expect much debate over the proposals in the coming months and encourage entities affected by the proposals to field test them to inform the IASB’s next steps.