The IASB has issued Risk Mitigation Accounting, an exposure draft of proposed amendments to IFRS 9 and IFRS 7, open for comment until July 31, 2026.

As IASB Chair Andreas Barckow puts it in the news release, the proposed (voluntary) model “aims to bring accounting and risk management closer together to enhance internal efficiency and strengthen communication between financial institutions and their stakeholders.”

It’s been a long time coming, dating back to a 2014 discussion paper; since then the project has been discussed at dozens of IASB meetings, every aspect painstakingly scrutinized and revised. The original discussion paper set out a fair-value based ‘portfolio revaluation approach’ to accounting for an entity’s dynamic interest rate risk management activities, but the IASB abandoned that approach, instead focusing more narrowly on repricing risk. The exposure draft defines this as a type of interest rate risk that exposes an entity to variability in the cash flows from, and the fair value of, financial instruments, arising from differences in: (a) the timing of when financial instruments reprice to benchmark interest rates; and (b) the amount of financial instruments that reprice in a particular period. In turn, net repricing risk exposure is the net exposure to repricing risk, based on the benchmark interest rate set by the entity, arising from underlying portfolios for which an entity manages repricing risk on a net basis. Against that backdrop, the premise underlying the exposure draft is this:

• If entities do not apply risk mitigation accounting, the use of derivatives to mitigate repricing risk often results in an accounting mismatch in profit or loss. This mismatch arises from differences in the timing of when an entity recognizes in profit or loss the repricing effects arising from its underlying portfolios, compared to the gains or losses on the derivatives. Applying risk mitigation accounting, an entity defers the recognition of the gains or losses on designated derivatives in profit or loss to the same period during which the repricing differences arising from the financial instruments in the underlying portfolios affect profit or loss.

In overview then, the model requires a entity:

• to plan (‘formally document’) how it will apply risk mitigation accounting;
• to identify the underlying portfolios that expose the company to repricing risk;
• to determine the net repricing risk exposure by allocating the underlying portfolios into repricing time bands based on expected repricing dates;
• to mitigate the risk using designated derivatives;
• to specify the risk mitigation objective;
• to construct benchmark derivatives to replicate the timing and amount of repricing risk specified in the risk mitigation objective; and
• to measure and recognize risk mitigation adjustments by comparing the fair value changes in the designated derivatives with those in the benchmark derivatives

The IASB isn’t proposing any changes to the measurement of either the financial instruments for which repricing risk is mitigated or the derivatives used to mitigate the risk. Instead, a participating entity would defer the recognition of the fair value changes in designated derivatives, recognizing the changes in profit and loss in the same reporting periods during which the repricing differences arising from the financial instruments in the underlying portfolios affect profit or loss. Prior to that, the exposure draft proposes that an entity recognizes the risk mitigation adjustment in the statement of financial position, measured at the lower of the cumulative gain or loss on the designated derivatives from the date the derivatives were designated; and the cumulative change in the fair value of the benchmark derivatives.

The exposure draft’s proposed disclosures cover just about every aspect of the model, including a breakdown that discloses a profile of the timings of the nominal amounts of the designated derivatives (for example, by repricing time bands), and their average fixed interest rate, accompanied by a sensitivity analysis showing how the cash flows from, or the fair value of, the underlying portfolios might change as a result of reasonably possible changes in the mitigated rate. Proposed disclosures also include tabular information about the financial instruments included in the underlying portfolios, aggregated to determine the net repricing risk exposure, and about designated derivatives, as well as a reconciliation from the opening to the closing balance of the risk mitigation adjustment.

It’s fairly esoteric stuff and I confess I don’t have the industry knowledge and expertise to comment even vaguely on the proposal’s merits. The basis for conclusions acknowledges that “risk mitigation accounting is inherently complex” and that “the expertise required in risk modelling and the related investment in systems and processes could impose high costs on entities:” it’s for this reason that the proposals are optional. One can’t help wondering though, notwithstanding that the document says the exposure draft’s proposals were supported by “most stakeholders” consulted along the way, whether that inherent complexity will limit their appeal, other than to the most specialized preparers and users…

The opinions expressed are solely those of the author.