How Will Tax Reform Impact Financial Institutions’ Investment Portfolios?

January 2018

With the President signing off on the Tax Cuts and Jobs Act on December 22nd, 2017 (effective January 1st, 2018), financial institutions (FIs) must determine how the changes will affect the business as a whole, as well as the outlook for their investment portfolios. The implications of the tax overhaul are widespread, and conducting a thorough analysis of your current investment portfolio is important to ensure that your firm is properly positioned.

This bulletin will provide you with an overview of some of the key changes made by the legislation, and the effect these changes may have on your fixed income portfolio.

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Cost of Funds Pressure

 

December 2017

 

Financial institutions have had success in keeping their cost of funds in check even after the Federal Reserve has raised short-term interest rates over the past few years. However, many financial institutions continue to use the same deposit betas in their interest rate risk modelling and financial forecasts that they utilized prior to the Federal Reserve rate hikes. The fact that these deposit betas have not been realized has been a large benefit to the financial institutions’ bottom lines.

 
 
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Hedge Accounting Transition Provisions upon Adoption of IFRS 9

 

October 2017



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Entities are required to adopt IFRS 9 for annual periods beginning on or after 1 January 2018 although early application is permitted. However, in relation to hedge accounting, entities have an accounting policy choice to ignore the hedge accounting provisions contained in Chapter 6 of IFRS 9 and continue applying the hedge accounting requirements of IAS 39 to all hedges. It is expected that this accounting policy choice will be removed once the IASB has completed its macro hedging project. Entities will have the ability to subsequently adopt the hedge accounting provisions of IFRS 9 after their initial adoption of IFRS 9 but would not be able to switch back to the IAS 39 hedge accounting provisions once IFRS 9 hedge accounting provisions have been adopted. The paragraphs below summarise the transition provisions for entities adopting Chapter 6 of IFRS 9.

 
 
 
 
 
 
 

The Impact of Adopting IFRS 9 on Effectiveness Testing, Ineffectiveness Measurement, and Rebalancing

 

October 2017



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Some of the most challenging elements of maintaining a hedging relationship under IAS 39 include complying with the periodic effectiveness testing requirements and properly measuring hedge ineffectiveness. Performing effectiveness testing often requires the use of complex quantitative analysis like statistical regression. Calculating the fair values of the derivatives and hedged items to be used in both the effectiveness testing and the measurement of hedge ineffectiveness often requires the use of sophisticated valuation models. Determining the appropriate methodology to value derivatives and the related hedged items represents another complex area for companies to navigate. The IASB attempted to simplify much of this with changes made to effectiveness testing in IFRS 9, which we will explore in this section.

 
 
 
 
 
 
 

Improved accounting for time value of options and other costs of hedging

 

October 2017



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IFRS 9 introduces several new concepts to the area of hedge accounting. One of these new concepts is “costs of hedging.” This new idea is intended to bring relief to companies that use options and forwards to hedge certain financial exposures. The costs of hedging will likely introduce some added benefit for companies seeking to use options, but may also create additional complexity around using cross-currency swap products.

 
 
 
 
 
 
 

New hedge accounting strategies and opportunities under IFRS 9

 

October 2017



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Potentially one of the greatest benefits from the new hedging standard is the added flexibility related to identifying the hedged item and corresponding hedged risk in a hedging relationship. The new guidance essentially broadens the universe of risks that are permissible to be hedged, making it more likely that corporate treasury groups will be able to economically hedge their risk exposures and obtain hedge accounting treatment for derivatives used to hedge such exposures.

 
 
 
 
 
 
 

Initial considerations before applying Hedge Accounting under IFRS 9

 

September 2017

 


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Companies adopting IFRSs have historically been applying the hedge accounting provisions under IAS 39 – Financial Instruments: Recognition and Measurement which was issued back in 2001. However, many companies felt that IAS 39 was difficult to apply due to some of its onerous provisions. Some of these include restrictions on the types of hedging relationships that can qualify for hedge accounting and the need to perform periodic quantitative effectiveness assessments that evaluate how well the hedge has performed at hedging the designated risk. The IASB heard the criticisms of IAS 39 and drafted a new standard, IFRS 9 published in November 2013, which includes provisions that are aimed at simplifying the application of hedge accounting and bringing it more in line with a company’s risk management activities.

 

Optimize Your Balance Sheet

 

September 2017

 

The FASB’s Accounting Standards Update (ASU) on derivatives and hedging provides much anticipated improvements to the hedge accounting framework in ASC 815. Financial institutions and other users of hedge accounting will benefit from the changes in the ASU. The effective date for public business entities will be fiscal years beginning after December 15, 2018 with early adoption permitted upon issuance of the final ASU (including interim adoption). Chatham Financial has followed this project very closely over the past several years and has had a significant role in working with the FASB to help shape the new guidance. Chatham can help identify the potential impact the new guidance may have on your hedging program.

 
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Assessing the impact of the FASB’s proposed changes to the hedge accounting rules under ASC 815

 

August 2017

 

Are you ready for the change? The FASB has been working on making changes to the hedge accounting guidance in ASC 815 for more than two years. Those changes will soon become effective and are geared towards bringing hedge accounting more in line with risk management activities. Potential changes to existing processes and strategies will present companies with new challenges and opportunities — is your hedging program optimized to take advantage of the changes when they go into effect?

 
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Liability Sensitive Financial Institutions – Improvements to Cash Flow Hedge Accounting

 

June 2017

 

The majority of medium-size commercial banks and most community banks are exposed to rising interest rates due to the natural composition of their balance sheet. They are often faced with high demand for fixed rate lending while they may not be able to secure long term fixed-rate financing of their own. As a result, they may alter their interest rate risk position by entering into pay-fixed, receive-floating interest rate derivatives to hedge their risk. These hedges are typically designated in cash flow hedging relationships against a variety of floating rate liabilities.

 
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