22.2 Cash flow hedge accounting
Cash flow hedge accounting significant accounting principles
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’ are transferred to the income statement for the given period.
Characteristics of cash flow hedge accounting
The Group applies:
- interest rate swaps (IRS) to hedge the exposure to interest rate risk related to the volatility of market reference rates (WIBOR, EURIOR), generated by portfolios of variable-rate loans denominated in PLN and EUR,
- 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 2022, Group extended the existing relationship (CFH IRS loans) with the current and future cash flows resulting from floating interest rate loans and bonds in EUR held by Bank, as well as intrest rate swap transactions hedging the interest rate risk in EUR.
In 2022, the Group stopped applying hedge accounting principles to one hedging relationship as a result of the expiry of hedging instruments: currency-interest swaps (basis swap) hedging a portfolios of loans and lease receivables with a floating interest rate in EUR and a portfolio of deposits in PLN economically constituting a long-term liability with a floating interest rate. Discontinuation of hedge accounting under the above-mentioned relationship had no impact on the income statement.
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, 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 Note 46.4.
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.