Among the recent comment on IAS 39's strict hedge effectiveness test requirements impact on commodity hedging comes an alternate proposal.

In its comment letter on the latest IAS 39 ED (see related item), Fair Value Hedge Accounting for a Portfolio Hedge of Interest Rate Risk, BHP Billiton, the UK-Australian, resource company, offers an interesting perspective on way out for the IASB in the current prospective effectiveness test debate. It suggests that the IASB allow fair value treatment of certain hedged items to offset the fair value of the hedge. And, in so doing, the firm also points to the fair value future beyond hedge accounting, which is the real source of the contentious IAS 39 debate.

Comment letter excerpts:

“For many organisations, the need for a hedge accounting solution is driven by the failure of the broader accounting framework to permit the financial statements to convey the risk and value of the underlying transactions to which an entity is exposed and which the entity may choose to mitigate. A far simpler solution is to permit entities to mark to market those transactions giving rise to a clearly measurable financial risk, even though the transactions are not themselves entirely of a financial nature. For example, where an entity enters into physical delivery transactions for commodities that are traded in a liquid market (such as LME traded metals and energy commodities), and that entity undertakes cash settled transactions for the purpose of modifying the overall financial risk exposure, a much simpler and more transparent accounting solution would be for all contracts, physical and cash settled, to be marked to market.”

Accordingly, as the company notes: “The concept of effectiveness within the hedge accounting model becomes redundant, as any deficiency in the effectiveness of the risk management programme will be displayed directly through net income. Designation of contract relationships is irrelevant as all contracts that meet the fair value measurement criteria (for example, contracts over LME traded commodities) are measured on a consistent basis.”

As more corporates come to terms with hedge accounting globally, perhaps more will join BHP Billington in urging the IASB to accelerate fair value treatment for certain non-financial items. It would not take much:

"Within IAS 39 in its present form, the only element preventing the above solution is the exclusion from mark to market accounting, of those embedded derivatives that are clearly and closely related to the host contract. For example, a fixed price contract to deliver aluminium at a future date is equivalent to a floating rate contract with an embedded floating to fixed price contract. The seller may enter into a cash settled contract involving the payment of the fixed price in return for a floating price. If the entity were able to mark to market the physical contract, or alternatively mark to market the embedded derivative in that contract, together with marking to market the cash settled contract, the financial statements would convey all exposures to price risk on the same commodity, and convey any failure of the risk management strategy to achieve mitigation of that risk."