Accounting for Derivatives: Advanced Hedging under IFRS 9, 2nd Edition

Chapter 8Hedging Foreign Currency Liabilities

The global nature of the capital markets allows many entities to fund in the lowest cost market available to them. Frequently, entities capture lower costs of funds and greater market liquidity by raising capital in currencies other than their functional currency. Because a foreign currency liability is a monetary item, IAS 21 requires the liability to be translated into the entity's functional currency using the exchange rate prevailing at the reporting date, as covered in Chapter 6. The translation gains or losses on the debt are recorded in profit or loss. Thus, absence of an FX hedging strategy may result in significant volatility in profit or loss. This chapter deals with the hedge accounting treatment of foreign currency borrowings swapped back into the issuer's functional currency.

The most common technique to hedge foreign debt is through cross-currency swaps (CCS) that convert the debt's foreign cash flows back into the entity's functional currency. Assuming the EUR as the issuer's functional currency and a USD-denominated debt, there are four potential hedging situations (which are covered in the four case studies in this chapter):

USD liability	CCS characteristics	Resulting EUR liability	Type of hedge
Floating	Receive USD floating – pay EUR floating	Floating	Fair value
Fixed	Receive USD fixed – pay EUR floating	Floating	Fair value
Floating	Receive USD floating – pay EUR fixed	Fixed	Cash flow
Fixed	Receive USD ...