What is Hedge Effectiveness?
Hedge effectiveness is the degree to which changes in the fair value or cash flows of a hedging instrument offset changes in the fair value or cash flows of a hedged item. Under IFRS 9, a hedging relationship qualifies for hedge accounting only if it meets effectiveness requirements at inception and throughout its life.
How It Works
- Identify and document the economic relationship between the hedging instrument and the hedged item.
- Confirm credit risk does not dominate value changes.
- Set a hedge ratio consistent with the actual quantity of hedging instrument and hedged item.
- Reassess at each reporting date and rebalance if needed.
Saudi Context
Saudi importers hedging USD currency exposure on imported equipment must demonstrate hedge effectiveness under IFRS 9 to qualify for hedge accounting and avoid P&L volatility.
Example
A forward contract to sell USD against SAR can be highly effective at hedging a USD-denominated receivable when the maturities match.