International Accounting Standards Board (IASB) has proposed amendments to IFRS 9 and IFRS 7 through an Exposure Draft, which includes:
A new model for accounting for risk mitigation related to repricing risk
Disclosure requirements for companies' strategies and effects of their risk management activities.
In the article, we will do a deep dive into the proposal and provide our perspective on these proposed amendments.
The proposed RMA model is a targeted, practical solution designed to fill a crucial gap in IFRS by accounting for dynamic macro risk management. Its strengths lie in improved alignment with risk management practices and enhanced transparency through robust disclosure requirements (IFRS 7). Its critical weakness is the deviation from the Conceptual Framework (recognition of the RMA) and the reliance on complex, internal proprietary models and assumptions necessary for determining exposure, adjusting benchmarks, and performing the realization test, which introduce ambiguity and potential complexity for preparers.
The RMA presented through amendments to IFRS 9 and IFRS 7, represents a comprehensive effort by the IASB to address long-standing challenges associated with accounting for dynamic risk management of open portfolios, particularly concerning repricing interest rate risk.
The critical analysis below draws upon the rationale, definitions, and proposed mechanics detailed in the Basis for Conclusions , the Exposure Draft , and the Illustrative Examples.
Analysis of Repricing Risk Management and Context
The RMA project was initiated because existing IFRS 9 hedge accounting requirements do not adequately cover portfolio (or macro) hedge accounting for open portfolios, which is commonly used to manage repricing risk. Repricing risk is the risk that financial instrument cash flows or fair values will vary due to timing or amount differences in their repricing to benchmark interest rates.
Practitioner Challenges and Market Risk Addressed
Macro Hedging Limitations: The core challenge practitioners faced under IFRS 9 or IAS 39 was that requirements were typically designed for closed portfolios and stable designations. This forced entities to account for dynamic risk management (DRM) as a series of frequently changing closed-portfolio scenarios, leading to complexities in tracking, amortization of hedge adjustments, and reclassification of deferred gains/losses. RMA aims to eliminate this operational inefficiency.
Addressing Accounting Mismatches: Entities primarily use RMA to faithfully reflect their repricing risk management activities, but a key secondary objective supported by stakeholders is the elimination of accounting mismatches. These mismatches occur when underlying financial assets or liabilities are measured at amortized cost (or FVTOCI) but the derivatives used to mitigate the risk are measured at fair value through profit or loss (FVTPL).
Inclusion of Difficult Exposures: RMA permits the inclusion of exposures that were difficult to qualify for hedge accounting under IFRS 9/IAS 39, such as:
Demand Deposits (Financial Liabilities Repayable on Demand): Although these instruments are measured at the nominal/demand amount for accounting purposes, entities often identify a stable, long-term portion that behaves like fixed-rate liabilities for risk management. RMA allows these to be included in underlying portfolios if assessed on a portfolio basis.
Financial Assets Measured at FVTOCI: While these are already measured at fair value on the Statement of Financial Position (SoFP), a mismatch remains in the Statement of Comprehensive Income (SCI) (derivative gains/losses in P/L, asset gains/losses in OCI). RMA resolves this P/L mismatch.
Focus on Repricing Risk: The model is specifically limited to addressing repricing interest rate risk. The flexibility in RMA (e.g., aggregating risk measures) is based on aligning with how banks, the main source of feedback, manage this specific risk dynamically, focusing on reducing variability in both earnings (short term) and economic value (long term).
Critical Analysis of the Proposed RMA Model
Conceptual Departure and Recognition
A significant aspect of the RMA proposal is the Risk Mitigation Adjustment, which is recognized in the Statement of Financial Position.
Our commentary: The IASB explicitly acknowledged that the RMA does not meet the definition of an asset or a liability set out in the Conceptual Framework for Financial Reporting. The IASB justifies this departure by concluding that it is necessary to faithfully represent the economic phenomenon of risk management activities and provide more useful information than volatile gains/losses in OCI would allow. This sets a precedent for standards departing from core definitions based on practical reporting objectives. It may have long term implications on future IFRS standards. It is appreciated that the scope of this departure is limited to specific risk management strategies.
Model Reliance on Internal Assumptions and Subjectivity
The RMA relies on an entity's internal risk management processes, which, while promoting better alignment between management and financial reporting, introduces areas of subjectivity:
Benchmark Derivatives (The Hypothetical Element): RMA uses benchmark derivatives i.e. theoretical instruments constructed to replicate the timing and amount of repricing risk specified in the risk mitigation objective.
Our commentary: The measurement of the RMA depends on comparing cumulative fair value changes of the designated derivatives against the cumulative change in fair value of these hypothetical benchmark derivatives (the ‘lower of’ requirement). Reliance on a theoretical construct, rather than a physical or observable item, increases complexity in valuation and subjects the reported RMA to the inherent assumptions used in constructing and measuring these benchmarks.
Net Repricing Risk Exposure (NRRE): Determining the NRRE requires aggregating repricing risk from underlying portfolios based on expected repricing dates. This necessitates using sophisticated internal models based on contractual and behavioral characteristics (e.g., prepayment models for mortgages, deposit decay models for demand deposits).
Our commentary: While RMA requires consistency with internal risk management measures (cash flow-based or fair value-based), the reliance on proprietary modelling and behavioral assumptions could hinder comparability between entities, even those in the same sector.
Complexity of Adjustments and the ‘Risk Mitigation Adjustment Excess’
The model requires adjustments for unexpected changes in the NRRE and an annual 'realization test', adding layers of complexity:
Benchmark Derivative Adjustment: If unexpected changes (e.g., prepayments) reduce the NRRE below the risk mitigation objective, the entity must adjust the benchmark derivatives.
Our commentary: While the IASB provides an operational simplification i.e. if reasonable and supportable information to estimate the effect of unexpected changes is not available without undue cost or effort, the entity may deem the changes to have occurred when the risk mitigation objective was last specified, the phrase "undue cost or effort" is inherently subjective and could be an area for varied application across preparers. For improved clarity, the final standard should provide stricter criteria or further guidance on demonstrating or justifying the use of this cost/effort exemption.
RMA Excess and Non-Reversal: At each reporting date, the entity must assess if the RMA might not be fully realized (e.g., due to unexpected changes). If the accumulated RMA exceeds the present value (PV) of the NRRE at the reporting date, the excess must be immediately recognized in P/L.
Our commentary: Calculating the PV of the NRRE is not simply the present value of the financial instruments but requires complex conceptual calculation (valuing a theoretical derivative mitigating the risk in full). While the IASB permits various approaches based on reasonable and supportable information, this calculation adds material ongoing cost and complexity. Crucially, the immediate recognition of the excess is not permitted to be reversed in future periods. This non-reversal policy aims to prevent potential earnings management but might result in instances where temporary adverse movements cause a permanent impairment of the RMA, potentially misrepresenting the long-term effectiveness of the risk mitigation efforts.
Scope and Discontinuation
Optionality and Comparability: The RMA is optional. While intended to prevent imposing high costs on entities lacking the necessary expertise, this optionality reduces comparability among financial institutions whose activities otherwise meet the eligibility criteria. The IASB attempts to mitigate this by requiring entities that do not apply RMA but meet the criteria to disclose qualitative information about how they manage repricing risk.
Discontinuation Criteria: Discontinuation is only permitted if there is a change in the entity's risk management strategy (e.g., changing the mitigated rate or the quantification measure). Changes resulting from the dynamic nature of operations (e.g., frequent changes to the risk mitigation objective or designated derivatives) do not justify discontinuation.
Our commentary: Defining the exact boundary between a permissible change in strategy (infrequent) and a dynamic change in activities (frequent) requires significant judgement and could be an area of ambiguity. The Illustrative Examples help clarify this, showing that changing the mitigated rate (SONIA to EURIBOR) or the risk measure (cash flow-based to fair value-based) constitutes a strategic change, whereas adjusting derivatives does not.
Proposed Improvements to the Proposal
Based on the analysis of challenges and ambiguities within the proposed framework, the following improvements could enhance its robustness and clarity:
Standardize Application of Operational Simplifications: The reliance on the "undue cost or effort" threshold when adjusting benchmark derivatives (to reflect unexpected changes) creates an area of ambiguity. The IASB should issue more granular implementation guidance or criteria specifying the types of evidence required to justify this exemption, thus standardizing its application and reducing the risk of inconsistent reporting.
Enhance Disclosure for Behavioral Assumptions: While the proposed amendments to IFRS 7 require disclosure of qualitative information regarding inputs and assumptions used (e.g., for demand deposits or prepayment models), the inherently subjective nature of these internal models warrants greater detail. Requiring entities to disclose the key parameters, sensitivity, and historical experience validation (e.g., deposit beta range) used in their internal models for behavioral adjustments, would allow users of such financial information to better evaluate the quality of the NRRE measurement.
Clarify the PV of NRRE Calculation: The calculation required for the RMA excess test i.e. determining the PV of the NRRE, is complex and lacks specific mandated methodology. While permitting flexible approaches, the IASB should mandate minimum required inputs and conceptual steps for calculating the PV of NRRE to ensure that the "reasonableness test" is applied consistently across institutions.
Review the Non-Reversal Rule for RMA Excess: The decision to prohibit the reversal of previously recognized RMA excess amounts (losses) eliminates potential earnings management but might hide genuine subsequent recovery of the risk position. IASB should consider allowing reversal of losses up to the amount of previous recognition, provided that the entity can demonstrate, using independent and robust measures, that the original underlying exposures supporting the loss recognition are now firmly protected, similar to certain impairment reversal rules, although the IASB rejected this based on management actions potentially driving the reversal.
We hope you find this deep dive on the IASB's potentially game changing risk management proposal insightful. The exposure period closes on 31 July 2026 allowing entities to fully evaluate the impacts of this proposal.
We strongly recommend all impacted entities to perform an in-depth impact analysis of this proposal to provide meaningful field-tested comments to IASB.