How does hedge effectiveness testing work under IFRS 9, and how does it differ from the old IAS 39 approach?
An advanced Corporate Treasury question — expect it in final rounds and case-heavy interviews (IB, PE, Big-4 Transaction Services).
THE SHORT ANSWER
Under IFRS 9, to apply hedge accounting the hedging relationship must meet three effectiveness requirements: there is an economic relationship between hedged item and hedging instrument (they move in opposite directions for the risk), credit risk does not dominate the value changes, and the hedge ratio designated reflects the actual quantities used (and isn't set to create an accounting outcome). Crucially, IFRS 9 removed IAS 39's rigid quantitative 80–125% effectiveness 'bright line' and the mandatory retrospective effectiveness test. Instead it's a more principles-based, prospective assessment — you can use a qualitative assessment where the critical terms match, or a quantitative method (regression, dollar-offset) where they don't. Any ineffectiveness is still measured and recognized in P&L each period, and you must rebalance the hedge ratio (rather than de-designate) if the economic relationship changes but the risk-management objective stays the same. The net effect: IFRS 9 better aligns hedge accounting with actual risk management and lets more economically sound hedges qualify than IAS 39's mechanical test allowed.
WHAT INTERVIEWERS LISTEN FOR
- ✓IFRS 9: economic relationship, credit risk not dominant, hedge ratio = actual quantities
- ✓Removed IAS 39's 80–125% bright line and mandatory retrospective test
- ✓Prospective, principles-based (qualitative if critical terms match)
- ✓Ineffectiveness still to P&L; rebalance rather than de-designate
COMMON MISTAKES
- ✗Citing the 80–125% rule as current IFRS 9
- ✗Not knowing the three IFRS 9 criteria
- ✗Forgetting ineffectiveness still hits P&L
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