Assessing MTM Cross-Currency Swaps in IFRS 9 Cash Flow Hedges
Summary
The document discusses whether a mark-to-market cross-currency swap with notional resets can serve as an effective hedge of foreign-exchange exposure under IFRS 9. It focuses on a hypothetical derivative used to represent the hedged item, noting a potential mismatch when the actual swap resets notionals but the hedged cash flows do not. A worked example considers a euro issuer hedging dollar bond cash flows and compares ordinary and MTM cash flow hedge accounting.
The example separates changes in the underlying cash flow value from basis effects and shows how an MTM receipt can be included in hedge profit and loss. In both illustrations, the stated accounting allocation comprises an effective hedge component and an ineffective component. The response suggests that basis measurements may differ slightly between swap structures. It does not establish a general accounting conclusion or provide authoritative IFRS 9 guidance; its final claim about regulatory and audit scrutiny is unsupported within the document.
Key ideas
- The question concerns whether MTM cross-currency swaps with notional resets can hedge foreign-exchange risk under IFRS 9.
- A hypothetical derivative should represent the underlying hedged cash flows, which can create a mismatch with a resetting swap.
- The example separates cash flow value changes from basis effects when assessing hedge effectiveness.
- An MTM receipt is included in hedge profit and loss in the illustrated accounting treatment.
- The worked example is explanatory and does not provide authoritative guidance for all hedge structures.
Tags
Full text
# IFRS9 hedge accounting - fx risk hedge with Cross currency swap with notional reset
# IFRS9 hedge accounting - fx risk hedge with Cross currency swap with notional reset
My understanding is that notional resetable cross currency swaps (MTM CCS) are very common amoung interbank markets, and MTM CCS are often used to hedge fx exposure. However, the notional resettable feature is not usaually included in hedged items, and hypothetical derivatives can not be created with the features which hedged items don't have under IFRS9, and so some ineffectiveness might occur between hypo with non notional reset feature and actual actual hedging MTM CCS Thus, I would like to understand the validity of MTM CCS as effective hedging items under IFRS9, and whether hypothetical deriva can have the feature of notional reset or not, considering hedge strategy and the fact that for major currencies, only MTM CCS is available in the interbank market.
## Answer by Attack68 (score 1)
https://quant.stackexchange.com/a/58457
If we work through this practically, a hypothetical derivative under IFRS9 cash flow hedge should be representative of the underlying, henceforth the MTM CCS must be mark to market on the currency side opposite to that of the hedged instrument.
For example, a EUR corporate might issue a yankee bond in 100mm USD and cross currency swap it back to EUR under a cash flow hedge. The cash flows of the USD bond, say 3M LIBOR, and the redemption of the 100mm USD at maturity should be matched on the currency swap. (This is non-standard in the first instance, since a EURUSD cross currency swap will MTM in USD not EUR, which would create the effect of only partially hedging the cashflows on the underlying USD bond). Lets assume that the MTM is performed in EUR and that the USD leg remains constant throughout the life of the swap, i.e. always replicates the bond cashflows.
Ordinarily an IFRS9 cashflow hedge is Non-MTM and the hedge PnL can be allocated by performing an analysis (npv-ing cashflows including basis adjustments and excluding them):
```
T_0 (usdeur=1) T_1 (usdeur=1.01)
Cashflow NPV € 1.0mm € 2.0mm
Cashflow NPV (inc basis) € 1.1mm € 2.3mm
```
Between accounting periods T_0 and T_1 the cashflow NPV has moved has moved by €1mm and the NPV including basis (i.e. real PnL of the derivative) has moved by €1.2mm, so the ineffective part of the hedge is assessed as € 0.2mm. The accounting would read:
```
Bond € -1mm
Hedge Effective € 1mm
Hedge Ineffective € 0.2mm
```
In this case, because the bond is floating rate, the explanation for the PnL change will be due to the EURUSD FX rate changing over the period. Essentially the liability (bond) will have increased because the USD has strengthened relative to EUR.
Now suppose instead that our cross currency derivative was not an ordinary IFRS9 non-mtm cashflow hedge but instead was a MTM cashflow hedge then we have the following:
```
T_0 (usdeur=1) T_1 (usdeur=1.01)
Cashflow NPV € 1.0mm € 1.0mm
Cashflow NPV (inc basis) € 1.1mm € 1.3mm
MTM receipt € 0 € 1.0mm
```
In this case the value of the derivative excluding basis is unchanged over the accounting period and the basis component is still measured as €0.2mm. However, the MTM payment (separated from regular coupon payments) must be recognised as being part of the hedge PnL so that we still record the same to the accounts:
```
Bond € -1mm
Hedge Effective € 1mm
Hedge Ineffective € 0.2mm
```
The basis component can vary by small amounts based on whether the swap is mtm or non-mtm but in an IFRS9 environment, given how esoteric these calculations are it would never be questioned by regulators or auditors.Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.