In dubio pro hedge?

An issue often raised by corporates of late has been which instruments will potentially not be recognized as hedges under the ESMA definition. 

You could be excused for thinking that an issue such as this would be relatively easy to resolve given that there are accounting standards which analogously also apply to corporates which do not directly apply these standards.

The legislator is (apparently) more lenient here and provides a broader definition: a derivative must foremostly, and possibly in a wider sense, be risk-mitigating in order not to be recognized as subject to the clearing threshold.  Does this clarify the issue?

Unfortunately not. Discussions have now been sparked in various fora as to whether certain instruments or scenarios trigger the recognition of the derivative, or, even better, a component of the derivative, with regard to the threshold.  Consider, for example, products such as 'interest rate swaps with potential gains' which have been sold en masse to corporates and some of which have led to nasty surprises. Such a swap transaction would in any case not be fully classified as a hedge under the ESMA definition and would require that the option component is reported separately, i.e. the transaction would have to be split into its risk-mitigating and speculative components even if the transaction as a whole were risk-mitigating. 

We still regard the issue of the clearing obligation as a 'non-event' from a corporate perspective, nevertheless it is not enough to simply define in an internal policy document that speculative derivatives may not be used.   You will have to prove this, particularly if the component is subject to audit control in Germany and also in other countries. This evidence will have to be provided in documentary form, making absolutely clear what was hedged with the derivative. According to the ESMA definition, this could be a derivative for a portfolio of forecast cash flows in a foreign currency. However, the question of whether an interest rate hedge for a loan which you know you are going to take out but the exact timing of which cannot yet be determined, is one about which opinions already diverge.  By the way, we are already of the opinion that this would be a risk-mitigating derivative as defined by ESMA, but would also like to make clear that this is only our opinion and is not to be taken for granted.

We will try to clarify this complex issue with auditors in the coming weeks. Irrespective of this, we recommend that all corporates who are not sure whether their hedging strategies and the instruments they employ are covered by the hedging definition discuss this with their auditors in good time.  The only thing which is really sure is that everything which is classified as a hedge under IFRS will also be a hedge as defined by EMIR. If not before, the 'excitement' will increase as soon as a derivative becomes ineffective.  In this case it could still be potentially risk-mitigating but will not be recognized as a hedge under IFRS.

In dubio pro hedge? We think that the opposite is likely to be the case. What do you think?