Hedging multiple layers in a closed portfolio

Prospective

Accounting for fair value basis adjustments

Modified retrospective basis^[5]

Disclosure of fair value basis adjustments

Prospectively or retrospectively

The following is a summary of the significant amendments to the portfolio layer method:

Scope

Expands application of the portfolio layer method to non-prepayable financial assets.

Multiple Hedged Layers

Allows designation of multiple layers in a single closed portfolio of financial assets (or one or more beneficial interests secured by a portfolio of financial instruments) as individual hedged items.

Partial-term Hedge

Allows the assumed maturity date of a hedged item to be at the end of the designated hedge period (which does not need to be a contractual coupon payment date).

Eligibility of Hedged Items

Permits designation of new hedging relationships and de-designation of existing hedging relationships associated with the closed portfolio any time after the closed portfolio’s initial hedge designation.

Types of Hedging Instruments and Layering Techniques

Permits use of different types of derivatives and layering techniques that best align with an entity’s individual circumstances (for example, spot-starting swaps, forward-starting swaps, or a combination of both).

The Update clarifies that if an entity is hedging multiple amounts in a closed portfolio with a single amortizing-notional swap, it is required to designate the hedge as a single-layer hedge, not hedges of multiple layers.

De-designation

If a breach (as defined below) has not occurred and one is not anticipated:

• an entity is allowed to fully or partially de-designate any hedge associated with the closed portfolio at any time.

 
If a breach is anticipated
(i.e., the aggregate amount of the hedged layers is no longer anticipated to be outstanding in future hedged periods):

• an entity is required to partially or fully de-designate a hedged layer or layers until a breach is no longer anticipated.

 
If a breach has occurred (i.e., the aggregate amount of the hedged layers currently exceeds the amount of the closed portfolio):

• an entity is required to partially or fully de-designate a hedged layer or layers until the aggregate amount of the hedged layers no longer exceeds the closed portfolio.

The Update requires an entity that hedges multiple layers to establish an accounting policy (no later than (i) when it first anticipates a breach or (ii) when a breach has occurred) that specifies a systematic and rational approach to determining which hedge or hedges to de-designate (or partially de-designate). Such policy should be consistently applied.

Hedge Basis Adjustments

Allocation to Individual Assets in an Existing Hedge

Prohibits allocating basis adjustments during an existing hedge either to the individual assets in the closed portfolio or to assets removed from the closed portfolio (for example, through prepayment, default, or voluntary sale or reclassification out of the closed portfolio).

Portion Associated with a Breach

Requires the reversal of the basis adjustment associated with a breached amount to be immediately recognized in interest income.

An entity is required to disclose the following:
a. The amount of the hedge basis adjustment recognized in current-period interest income because of the breach

b. The circumstances that led to the breach.

Determining the Portion Attributable to the Hedged Risk Associated with the Available-for-Sale (AFS) Debt Securities

If a closed portfolio includes AFS debt securities and assets that are not AFS debt securities:

• an entity is required to determine the portion of the basis adjustment attributable to the AFS debt securities using a systematic and rational method. That amount is then recognized in earnings each period (rather than in other comprehensive income), but it should not be used to adjust the carrying amount of the individual AFS debt securities in the closed portfolio.

Since the basis adjustment associated with the AFS debt securities does not adjust any individual security’s carrying amount while the hedge remains designated, no amount of the hedged layer’s basis adjustment would be used to determine the gain or loss on sale if a security is sold.

Interaction with Credit Loss Guidance

Prohibits an entity from considering basis adjustments on existing portfolio layer method hedges when measuring credit losses on the assets included in the closed portfolio.

Presentation

Prohibits an entity from disclosing the outstanding basis adjustment on a more disaggregated basis than the closed portfolio basis; however:

• if the assets included in the same closed portfolio are presented in different line items in the balance sheet, an entity shall allocate the basis adjustment to the assets’ associated line items in the balance sheet using a systematic and rational method.

Other Disclosure Matters

If other Topics require the disclosure of the amortized cost basis of assets included in the closed portfolio on a more disaggregated basis, the entity shall exclude the basis adjustment from the amortized cost basis of those assets.

An entity is required to disclose:

• the total amount of the basis adjustment excluded from the amortized cost basis of the assets included in the closed portfolio.