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What is a hedging relationship?

Regulations 7, 8 and 9 all require a ‘hedging relationship� between a derivative contract and a particular hedged item. Regulation 2(5) defines what is meant by a ‘hedging relationship�.

If the derivative and the hedged item are accounted for by the company as a hedge in accordance with IFRS, New UK GAAP or FRS 26 of Old UK GAAP, there is automatically a ‘hedging relationship� for the purposes of the Disregard Regulations. Where a hedging relationship has been accounted for as a hedge under the relevant accounting standard, the company will have documented its hedging strategy, and the nature and purpose of the particular hedge under consideration, CFM27070.

»Ê¹ÚÌåÓýappre may, however, be a ‘hedging relationshipâ€� for tax purposes even where the criteria in IFRS, New UK GAAP, or FRS 26 of Old UK GAAP for hedge accounting are not satisfied. »Ê¹ÚÌåÓýapp test is whether the hedging instrument is intended to act as a hedge of:

• the exposure to changes in fair value of an asset or liability, or an unrecognised firm commitment, which is attributable to a particular risk and could affect the company’s profit or loss;
• the exposure to variability in cash flows associated with an asset, liability or forecast transaction, which is attributable to a particular risk and could affect profit or loss; or
• a net investment in a foreign operation of the company.

CFM57060 gives guidance on the interpretation of ‘intended to act as a hedge�.

A ‘hedging instrument� may comprise all or only part of a derivative contract. Similarly, the ‘hedged item� may be all or only part of the overall asset, liability or transaction.