23. Hedge accounting

Derivative hedging financial instruments are initially recorded at fair value as at the transaction date and subsequently remeasured at fair value at each balance sheet date. The fair value is established on the basis of market quotations for an instrument traded in an active market, as well as on the basis of valuation techniques, including models using discounted cash flows and options valuation models, depending on which valuation method is appropriate.

Positive valuation of derivative hedging financial instruments is presented in the statement of financial position in the line ‘Hedging instruments’ on an asset side, whereas the negative valuation – ‘Hedging instruments’ on a liabilities side.
The Group designates some of its derivative instruments as hedging items in applying hedge accounting. The Group decided to take advantage of the choice which gives IFRS 9 and continues to apply the hedge accounting requirements of IAS 39. This decision will apply to all hedging relationships, for which the Bank applies and will apply hedge accounting in the future. The Bank implemented fair value hedge accounting as well as cash flow hedge accounting.

Changes in the measurement to fair value of financial instruments indicated as hedged positions are recognized – in the part ensuing from hedged risk – in the income statement. In the remaining part, changes in the carrying amount are recognized in accordance with the principles applicable for the given class of financial instruments.

Changes in the fair market valuation of derivative financial instruments, indicated as hedging positions in fair value hedge accounting, are recognized in the profit or loss in the same caption, in which the gains/losses from change in the value of hedged positions are recognized i.e. in the item ‘Net income from fair value hedge accounting’.

Interest income on derivative instruments hedging interest positions hedged is presented as interest margin.

The Group ceases to apply hedge accounting, when the hedging instrument expires, is sold, dissolved or released (the replacement of one hedging instrument with another or extension of validity of given hedging instrument is not considered an expiration or release, providing such replacement or extension of validity is a part of a documented hedging strategy adopted by given unit), or does not meet the criteria of hedge accounting or the Group ceases the hedging relation.

An adjustment for the hedged risk on hedged interest position is amortized in the income statement at the point of ceasing to apply hedge accounting.

Changes in the fair value of the derivative financial instruments indicated as cash flow hedging instruments are recognized:

• directly in the caption ‘Revaluation reserves’ in the part constituting the effective hedge,
• in the income statement in the line ‘Result on financial assets and liabilities held for trading and foreign exchange result’ in the part representing ineffective hedge.

The amounts accumulated in the ‘Revaluation reserves’ are transferred to the income statement in the period, in which the hedge is reflected in the income statement and are presented in the same lines as individual components of the hedged position measurement, i.e. the interest income from hedging derivatives in cash flow hedge accounting is recognized in the interest result, whereas gains/losses from foreign exchange revaluation are presented in the foreign exchange gains (losses).

The Group ceases to apply hedge accounting when the hedging instrument expires or is sold, or if the Group revokes the designation, or when hedge no longer meets the criteria for hedge accounting. In such cases, the accumulated gains or losses related to such hedging item, initially recognized in ‘Revaluation reserves’, if the hedge was effective, are still presented in equity until the planned transaction was closed and recognized in the income statement.

If the planned transaction is no longer probable, the cumulative gains or losses recognized in ‘Revaluation reserves’ aretransferred to the income statement for the given period.

As of 31 December 2021 the Group applies fair value hedge accounting and cash flow hedge accounting:

FVH – fair value hedge accounting:

• Interest rate swaps (IRS) designated to hedge debt securities denominated in PLN, EUR and USD (hereafter: FVH IRS bonds).

CFH – cash flow hedge accounting:

• Interest rate swaps (IRS) designated to hedge floating rate loans and securities denominated in PLN (hereafter: CFH IRS loans),
• Interest rate swaps (IRS) designated to hedge deposits denominated in PLN and EUR, which economically reflect long-term variable-rate liability (hereafter: CFH IRS deposits),
• cross-currency interest rate swaps (basis swap) designated to hedge floating rate loans denominated in CHF and liabilities denominated in PLN, which economically reflect long-term variable-rate liability (link extended by the current future cash flows resulting from loans and lease receivables with a variable interest rate in EUR hereafter: CFH CIRS),
• FX-Swaps designated to hedge floating rate loans denominated in EUR and current and term deposits denominated in USD (two hedging relationships, jointly hereafter: CFH FX-Swap).

As part of the established hedging relationships, the Group identifies the following interest rate benchmarks: WIBOR,EURIBOR, LIBOR CHF, LIBOR USD. As of the reporting date, these benchmarks rates are quoted and available each day and resulting cash flows are exchanged with its counterparties as usual.

In the case of WIBOR and EURIBOR the Group assessed that, there is currently no uncertainty about the timing or amounts of cash flows arising from the IBOR reform. Both benchmarks have been adapted to the requirements of European Union Benchmark Regulation (BMR Regulation) and are developed by Administrators with the approval of supervisory authorities. The Bank not anticipate changing the hedged risk to a different benchmarks.

For LIBOR CHF and LIBOR USD, the established hedging relationships extend beyond the anticipated cessation dates for both benchmarks, i.e. 31 December 2021 for CHF LIBOR and 30 June 2023 for USD LIBOR.

From January 1, 2022, under the Commission Implementing Regulation (EU), the LIBOR CHF benchmarks were replaced by the SARON (Swiss Averaged Rate Overnight) and SARON Compound benchmarks administered by the SIX Swiss Exchange, thus uncertainty about the timing and amounts of cash flows for the new benchmarks is finished. The Group plans to continue the existing relationship after switching to SARON benchmarks, using the procedure and in accordance with the principles set out in the amendments to IAS 39 and IFRS 9 concerning the IBOR reform. In the Group’s opinion, it is reasonable to expect that the hedge will be highly effective and efficient in all reporting periods for which the hedge has been established.

The Group expects that LIBOR USD benchmarks will be replaced by the SOFR (Secured Overnight Financing Rate) administered by the Federal Reserve Bank of New York, but there is uncertainty about the timing and amounts of cash flows for the new rates. Such uncertainty may impact the assessment of: the effectiveness of the relationship and the high probability of the hedged item. For the purposes of these assessments, the Group assumes that the hedged interest rates benchmarks on which the cash flows of the hedged item and / or the hedging instrument are based will not be altered as a result of IBOR reform.

Below is the list of hedging relationships and the nominal amounts of hedging instruments designated thereto, which may be affected by the cessation of the LIBOR interest rate benchmarks as at 31 December 2021:

• FVH IRS bonds (USD 133 million transactions based on USD LIBOR, maturing after 30June 2023).

Regarding the hedging instruments, the Bank joined ISDA Fallbacks Protocol and actively cooperates with counterparties in order to implement rules of conduct in line with the ISDA methodology.

The Group applies fair value hedge accounting for fixed coupon debt securities denominated in PLN, EUR and USD, hedged with interest rate swap (IRS) transactions in the same currencies. The Group hedges component of interest rate risk related to the fair value changes of the hedged item resulting exclusively from the volatility of market interest rates (WIBOR, EURIBOR, LIBOR USD). In the past, hedged risk component accounted for a significant portion of changes in fair value of the hedged item.

The approach of the Group to market risk managemant, including interest rate risk, and details regarding exposure of the Group to interest rate risk are disclosed in Note 47.4.
The use of derivative instruments to hedge the exposure to changes in interest rates generates counterparty credit risk of derivative transactions. The Group mitigates this risk by requiring the counterparties to post collateral deposits and by settling derivative transactions through Central Counterparty Clearing Houses (CCPs) whch apply a number of mechanisms allowing systemic reduction of the risk of default on obligations under concluded transactions.

The Group applies fair value hedge accounting to a hedging relationship if it is justified to expect that the hedge will be highly effective in achieving offsetting fair value changes attributable to the hedged risk in the future and if assessment of hedge effectiveness indicates high effectiveness in all financial reporting periods for which the hedge was designated.

According to the approach of the Group, hedge ratio is determined as ratio of fair value of the hedged item to fair value of the hedging instrument. A hedging relationship is considered effective if all of the following criteria are met:

• high effectiveness of the hedge can be expected on the basis of comparison of critical terms of the hedged item and the hedging instrument,
• in each reporting period, hedge ratio is within 80% – 125% range or relation of inefficiency amount to nominal value of the hedged item is less or equal than the threshold specified in documentation of the hedging relationship, where inefficiency amount is calculated as the sum of cumulative fair value changes of the hedged item and the hedging
  instrument,
•  in each reporting period, simulation of hedge ratio in assumed evolution of market rates scenarios is within 80% – 125% range.

As regards fair value hedge relationships, the main sources of ineffectiveness are:

• impact of the counterparty credit risk and own credit risk of the Group on the fair value of the hedging transactions (IRS), which is not reflected in the fair value of the hedged item,
• differences in maturities of the interest rate swaps and debt securities,
• differences in coupon amounts generated by the hedged item and hedging instruments

The tables below present interest rate swaps which are used by the Group as instruments hedging interest rate risk in fair value hedge accounting as of 31 December 2021 and 31 December 2020.

Nominal values and interest rates of hedging derivatives – fair value hedge

Impact of fair value hedge (interest rate risk hedging) on balance sheet and financial result

• cross-currency interest rate swaps (basis swap) to hedge exposure to interest rate risk related to volatility of market reference rates (WIBOR, EURIBOR, LIBOR CHF – replaced by SARON from 1 January od 2022) and exposure to currency risk. Portfolios of variable-rate loans denominated in CHF, variable-rate loans and leasing receivables denominated in EUR and deposits in PLN (which economically constitute a long-term variable-rate liability) are hedged items in this hedging relationship. CIRS transactions are decomposed into the part hedging the portfolio of assets and the part hedging the portfolio of liabilities,
• interest rate swaps (IRS) to hedge the exposure to interest rate risk related to the volatility of market reference rates (WIBOR), generated by portfolios of variable-rate loans denominated in PLN,
• currency swaps (FX-Swap) to hedge the exposure to the currency risk, generated by both, portfolios of loans denominated in EUR and portfolios of current and term deposits denominated in USD,
• interest rate swaps (IRS) to hedge the exposure to interest rate risk related to the volatility of market reference rates (WIBOR, EURIBOR), generated by portfolio of deposits denominated in PLN and EUR, which economically constitute a long-term, variable-rate liability.

In 2021, Group extended the existing relationship (CFH CIRS deposits/loans) with the current and future cash flows resulting from floating interest rate loans and lease receivables in EUR, as well as EUR/PLN basis swap transactions hedging currency and interest rate risk.

Approach of the Group to hedging interest rate risk through cash flow hedge accounting is the same as the approach applied in the fair value hedge accounting as described above, i.e. only the component of interest rate risk related exclusively to volatility of market reference rates (in the case of cash flows hedge: WIBOR, EURIBOR, LIBOR USD, LIBOR CHF) is hedged.

Approach of the Group to market risk management, including interest rate risk and currency risk, and details regarding the Bank’s interest rate risk and currency risk exposure are disclosed in w Note 47.4.

As in the case of the fair value hedge, using derivative instruments to hedge the exposure to interest rate risk and currency risk generates counterparty credit risk of the derivative transactions, which is not compensated by the hedged item. The Group manages this risk in a way similar to fair value hedge.

The Group applies cash flow hedge accounting to a hedging relationship if it is justified to expect that the hedge will be highly effective in achieving offsetting cash flow changes attributable to the hedged risk in the future and if assessment of hedge effectiveness indicates high effectiveness in all financial reporting periods for which the hedge was designated. The assessment is conducted using hypothetical derivative method.

According to the approach of the Group, a hedging relationship is considered effective if all of the following criteria are met:

• correlation coefficient between market reference rate of hedged items and market reference rate of hedging instrument is high,
• forecasted interest flows generated by hedged items are not lower than forecasted interest flows generated by hedging instruments,
• in each reporting period, ratio of the fair value of the hedged item to the fair value of the hedging instrument is within 80% – 125% range or relation of inefficiency amount to nominal value of the hedged item is less or equal to the threshold specified in documentation of the hedging relationship, where inefficiency amount is calculated as the sum of cumulative fair value changes of the hedged item and the hedging instrument,
• in each reporting period, simulation of hedge ratio in assumed evolution of market rates scenarios is within 80% – 125% range

In the case of hedging interest rate and currency risk of portfolios of loans and deposits, the manner of managing these portfolios was adopted allowing for regular inclusion of new transactions in the hedging relationship and exclusion of transactions from the hedging relationship as a result of repayment or classification to non-performing category. As a result, the exposure of these portfolios to interest rate and currency risk is constantly changing.

Because of frequent changes to term structure of the portfolio, the Group dynamically assigns the hedged items and allows for matching of hedging instruments to these changes.

As regards cash flow hedge relationships, the main sources of ineffectiveness are:

• impact of counterparty and the Group’s own credit risk on the fair value of the hedging instruments, i.e. interest rate swap (IRS), cross-currency interest rate swap (basis swap), currency swap (FX swap) which is not reflected in the fair value of the hedged item,
• differences in repricing frequency of the hedging instruments and and hedged loans and deposits.

Nominal values and interest rates of hedging derivatives – cash flow hedge

Impact of cash of hedge on balance sheet and financial result

Impact of cash of hedge on balance sheet and financial result

Changes in the revaluation reserve from the valuation of hedging derivatives in cash flow hedge accounting