As we addressed here, IASB recently issued the exposure draft Contracts for Renewable Energy.

We already looked at the proposals relating to applying the ‘own-use’ requirements. The exposure draft also addresses the IFRS 9 hedge accounting requirements, noting that application challenges arise in designating and measuring the hedged item if a contract for renewable electricity with a variable nominal amount (that is, a PPA) is designated as the hedging instrument. It goes on:

• IFRS 9 generally requires the hedged item to be designated as a specified nominal amount or volume, or a component of such a nominal amount or volume. For example, an entity may designate the first 100 MWh of electricity sales in June 202X or the bottom layer, measuring 5 million cubic metres of natural gas stored in location XYZ. Any changes to the hedged item, such as a change in the nominal amount or volume to be designated, would result in the discontinuation of the hedging relationship because such changes indicate a change in the entity’s documented risk management objective.
• In most cash flow hedging relationships, the only cash flow variability that arises is resulting from the changes in the hedged risk, for example the market price of a non-financial item. However, when using a contract for renewable electricity as the hedging instrument, cash flow variability also arises because the nominal amount or volume of that instrument is variable. This volume variability arises because the source for the production of renewable electricity is nature-dependent…
• Designating from a seller’s perspective a consistent volume of renewable electricity as the hedged item might often result in hedge accounting being applied to only a small portion of an entity’s forecast renewable electricity sales because the actual volume produced would be expected to be highly variable as a result of the nature-based conditions. For example, although a production facility might have a maximum capacity of 1,000 MWh, the volumes expected to be produced (applying probability-weighted scenario analysis) ranges between 300 MWh and 600 MWh. Nevertheless, the volume of forecast sales that will occur with enough certainty and consistency to meet the requirement for the transaction to be highly probable (as required by paragraph 6.3.3 of IFRS 9) throughout the duration of the renewable electricity contract is only 100 MWh. In this scenario, the entity would be able to designate only 100 MWh as the hedged item for the duration of the hedging relationship, despite the contract for renewable electricity providing a highly effective economic hedge for any volume of electricity the entity produces and sells. Although the entity might be able to designate a qualifying hedging relationship, the fact that the hedged item has a fixed nominal volume compared to a variable nominal volume in the hedging instrument inevitably results in hedge ineffectiveness. The IASB acknowledged that such a designation will not appropriately consider the contractual link between the hedged item (being the electricity produced and sold) and the hedging instrument (being the contract for renewable electricity), which economically results in all the electricity produced to be fully hedged.

Taking this and other challenges into account, the IASB proposes permitting an entity to designate the hedged item as the variable volume of renewable electricity to which the hedging instrument relates, as long as (in most cases) the variable volume of forecast electricity transactions so designated doesn’t exceed the volume of future electricity transactions that is highly probable. As with the own-use proposals, a member of the IASB dissented because he “does not believe there is any principle-based reason as to why, for these types of contracts, an entity should be allowed to designate a variable nominal amount while being prevented from doing so for other contracts with similar economics. In his opinion there are no unique features of contracts for renewable electricity that justify such a drastic amendment.” He believes “the IASB should rather have looked at a comprehensive solution for potential amendments that would have affected all cash flow hedging relationships and not just those in the scope of the proposals.”

I suppose the majority of the board though took the view that the proposals would allow the entities entering into these contracts to appropriately reflect the results of their risk management activities in the financial statements, and that this is a virtuous step even if it carries the slight air of a carve-out from the usual principles, reached as a concession to the louder voices in the room (to ensure that constituents share its sense of urgency, the IASB shortened the comment period to 90 days rather than the usual 120 days, and included in the news release a link to an article reporting that “corporations publicly announced a record 46 gigawatts (GW) of solar and wind contracts in 2023, some 12% more than the previous record of 41GW in 2022.”) I seldom write about hedge accounting in this space, probably because my grasp of it is imperfect, but I imagine that if I did perfectly grasp it, I’d be all for what they’re suggesting!

The opinions expressed are solely those of the author.