IFRS 9: documenting an FX hedging relationship, from designation to the equity reserve

A mid-sized subsidiary of a listed group, or a group reporting under international standards, applies IFRS 9 to its FX hedges. The difference with French GAAP is stark: under IFRS, all derivatives are on the balance sheet at fair value, and their changes go through profit. Hedge accounting is the exception that keeps profit from swinging with exchange rates — and it is a choice the company must make, with documents to back it, from the outset.

Without hedge accounting: profit on a roller coaster

Take a company that hedges its next twelve months of dollar purchases with forwards. The purchases are not yet booked; the forwards are remeasured at every reporting date. If the dollar falls, the forwards lose value and the loss hits profit — while the future purchases will cost less, which will only show later. The hedge works economically, but the income statement says the opposite.

Cash flow hedge accounting corrects this mismatch: the effective portion of the derivative's change is recorded in equity, then released to profit when the hedged purchases affect it.

IFRS 9's conditions

A hedging relationship qualifies for hedge accounting only if all the following criteria are met (IFRS 9, paragraph 6.4.1):

1. it consists only of eligible hedging instruments and hedged items;
2. from inception, it is formally designated and documented;
3. it meets the three effectiveness requirements: an economic relationship between hedged item and instrument, credit risk that does not dominate value changes, and a hedge ratio consistent with the quantities actually hedged.

For a forecast transaction — planned sales or purchases — the transaction must also be highly probable (paragraph 6.3.3).

What the documentation must contain

Effectiveness: no more 80-125% threshold

The previous standard, IAS 39, imposed a numerical test: the hedge had to offset between 80% and 125% of the changes in the hedged item. IFRS 9 removed it. It prescribes no method, but requires one that captures the relevant characteristics of the relationship (paragraph B6.4.13).

• The assessment is forward-looking: it concerns what is expected of the hedge.
• It is performed at inception and then at least at each reporting date, or earlier on a significant change in circumstances (paragraph B6.4.12).
• To measure ineffectiveness, a "hypothetical derivative" matching the critical terms of the hedged item may be used; for a two-sided hedged risk, it is calibrated to a value of nil at designation (paragraph B6.5.5).

How the hedge reserve works

For a cash flow hedge, the reserve recorded in equity is adjusted to the lower, in absolute terms, of two amounts: the cumulative gain or loss on the instrument since inception, and the cumulative change in the value of the hedged item. The effective portion goes to equity; the rest is ineffectiveness, recognised in profit (paragraph 6.5.11).

The reserve is released in two ways. If the hedged purchase results in a non-financial asset — an inventory of goods —, the amount is removed from the reserve and included directly in the cost of the asset. Otherwise, it is reclassified to profit when the hedged cash flows affect it.

Forward points and time value: the "cost of hedging"

The company may designate as the hedging instrument only the spot element of a forward, excluding the forward points, or only the intrinsic value of an option, excluding its time value. The excluded elements can then follow a "cost of hedging" treatment: their changes pass through a separate reserve in equity instead of hitting profit (paragraphs 6.5.15 and 6.5.16).

Rebalance, don't abandon

If the hedge ratio no longer meets the effectiveness requirement but the risk management objective remains the same, the company adjusts the ratio: this is rebalancing (paragraph 6.5.5). It may only discontinue hedge accounting when the relationship no longer meets the criteria — for example on maturity or sale of the instrument (paragraph 6.5.6). Voluntary discontinuation, at will, is not possible.

What hedging changes for the notes

Companies applying hedge accounting publish specific disclosures under IFRS 7: risk management strategy, the effect of hedges on future cash flows, reconciliation of the hedge reserve from one year to the next. FX derivatives are also classified in the IFRS 13 fair value hierarchy, most often at level 2, that of observable market inputs.

Sources

• IFRS 9 Financial Instruments, chapter 6 (hedge accounting), as adopted in the European Union: paragraphs 6.3.3, 6.4.1, 6.5.5, 6.5.6, 6.5.11, 6.5.15, 6.5.16, B6.4.12, B6.4.13 and B6.5.5. Paragraphs checked against the compiled version of the Australian standard AASB 9 (March 2026), which reproduces IFRS 9 word for word with the same numbering.
• IAS 39 Financial Instruments: Recognition and Measurement, paragraph AG105 (80% to 125% range, dropped by IFRS 9).
• IFRS 7 Financial Instruments: Disclosures, and IFRS 13 Fair Value Measurement.