DRM, « Dynamic Risk Management », what does it mean?
François Masquelier, Vice Chairman of EACT
It looks like a new “Risk Management” technique for treasurers. DRM stands for Dynamic Risk Management”. It is the acronym used by the IASB (IFRS body in London) to address the netting issue.
If you remember IFRS 9 has aligned Hedge Accounting rules closer to risk management approaches. It has also established a more principle-based approach to Hedge Accounting and have eventually addressed inconsistencies and weaknesses in the Hedge Accounting model of IAS 39. They have decided to address the “macro hedging” in a separate document. IASB has recently published a DP (i.e. Discussion Paper) exploring a new approach to better reflect the companies’ “Dynamic Risk Management” activities in the financial statements, otherwise known as “macro hedging”. Many companies manage risks, such as Interest Rates, with a dynamic manner, on a portfolio basis rather than on an individual contract basis.
"What is a “Dynamic Risk Management” approach? It is a continuous process because the risks the preparers face evolve overtime."
What is a “Dynamic Risk Management” approach? It is a continuous process because the risks the preparers face evolve overtime. Under current IAS 39, it is generally considered to be difficult to apply when accounting as for such type of transactions, which would require a more dynamic approach. After the crisis, IASB has decided to replace IAS39 by IFRS9 (new standard applicable since 1st of January 2018). It was a very long-awaited standard in its final stage of completion. However, we can admit that it corrected lots of issues raised by IAS 39 and all-in is a clear and real enhancement of former standard. Nevertheless, the macro-hedging piece was still missing. They have started to work on it. It won’t be an easy journey for the Board. As said, it was decided at the early stages that the IASB will treat the macro-hedging component as a separate project, to avoid an even broader range of constituents.
"The idea is to address the situation when the risk position being hedged experiences frequent changes."
This DP represented a 1st step of the project and was aimed at collecting comments from users and preparers on the possible approach to accounting for an entity’s dynamic risk management activities, so called “Portfolio Revaluation Approach” (PRA). The Board plans to develop an accounting model for interest rates which could be extended to other asset classes. The idea is to address the situation when the risk position being hedged experiences frequent changes. All improvements of IFRS 9 have been designed with a static risk management strategy approach in mind. The Board intended to pursue the aim by developing accounting requirements for hedging within the context of open portfolios, which are more closely aligned with an entity’s risk management activity and by reducing operational complexities. The PRA to macro-hedging consists of a new accounting model. In this model the company will adjust the exposures that are dynamically risk managed to reflect the effect of changes in value that arise from the risks that are being managed. One of the main issues is the fact that it is open and dedicated as it is to banks.
The corporates should certainly try to express their views too. Although the status quo seems not to be acceptable for the Board, moving this project forward will be challenging and very complicate given implications. The objectives of banks are certainly different and maybe opposite to those of corporates. As always in such situations, the most vocal will potentially obtain some results. If you do not express your views, be sure you will be forgotten. It is certainly a topic on which treasurers should focus in the coming months if they want to have a slight chance to get something useable and practicable. It will be a very challenging issue that can last for months and even years I’m afraid. Let’s be ready to face some difficulties.