ING Direct 2008 Annual Report Download - page 143

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ING Group Annual Report 2008
To qualify for hedge accounting under IFRS-EU, strict criteria must be met. Certain hedges that are economically effective from a risk
management perspective do not qualify for hedge accounting under IFRS-EU. The fair value changes of derivatives relating to such non
qualifying hedges are taken to the profit and loss account. However, in certain cases, the Group mitigates the resultant profit and loss
account volatility by designating hedged assets and liabilities at fair value through profit and loss. If hedge accounting is applied under
IFRS-EU, it is possible that during the hedge a hedge relationship no longer qualifies for hedge accounting and hedge accounting cannot
be continued, even if the hedge remains economically effective. As a result, the volatility arising from undertaking economic hedging in
the profit and loss account may be higher than would be expected from an economic point of view.
With respect to exchange rate and interest rate derivative contracts, the notional or contractual amounts of these instruments is indicative
of the nominal value of transactions outstanding at the balance sheet date; however they do not represent amounts at risk. ING Group
uses credit derivatives to manage its exposure to credit risk, including total return swaps and credit default swaps, to sell or buy protection
for credit risk exposures in the loan, investment and trading portfolios. Hedge accounting is not applied in relation to credit derivatives.
Fair value hedge accounting
ING Group’s fair value hedges principally consist of interest rate swaps and cross-currency interest rate swaps that are used to protect
against changes in the fair value of fixed-rate instruments due to movements in market interest rates.
Gains and losses on derivatives designated under fair value hedge accounting are recognised in the profit and loss account. The effective
portion of the fair value change on the hedged item is also recognised in the profit and loss account. As a result, only the net accounting
ineffectiveness has an impact on the net result.
For the year ended 31 December 2008, ING Group recognised EUR –5,492 million (2007: EUR 697 million) of fair value changes on
derivatives designated under fair value hedge accounting in the profit and loss account. This amount was partly offset by EUR –5,697
million (2007: EUR 663 million) fair value changes recognised on hedged items. This resulted in EUR 205 million (2007: EUR 34 million) net
accounting ineffectiveness recognised in the profit and loss account. As at 31 December 2008, the fair values of outstanding derivatives
designated under fair value hedge accounting was EUR –5,050 million (2007: EUR 994 million), presented in the balance sheet as
EUR 3,862 million (2007: EUR 1,952 million) positive fair values under assets and EUR 8,912 million (2007: EUR 958 million) negative fair
values under liabilities.
ING Group applies fair value hedge accounting for portfolio hedges of interest rate risk (macro hedging) under the EU ‘carve out’ of
IFRS-EU. The EU ‘carve-out’ macro hedging enables a group of derivatives (or proportions) to be viewed in combination and jointly
designated as the hedging instrument and removes some of the limitations in fair value hedge accounting relating to hedging core
deposits and under-hedging strategies. Under the IFRS-EU ‘carve-out’, hedge accounting may be applied to core deposits and
ineffectiveness only arises when the revised estimate of the amount of cash flows in scheduled time buckets falls below the designated
amount of that bucket. ING applies the IFRS-EU ‘carve-out’ to its retail operations in which the net exposure of retail funding (savings and
current accounts) and retail lending (mortgages) is hedged. The hedging activities are designated under a portfolio fair value hedge on
the mortgages, using the IFRS-EU provisions.
Cash flow hedge accounting
ING Group’s cash flow hedges principally consist of (forward) interest rate swaps and cross-currency interest rate swaps that are used
to protect against its exposure to variability in future interest cash flows on non-trading assets and liabilities that bear interest at variable
rates or are expected to be refunded or reinvested in the future. The amounts and timing of future cash flows, representing both
principal and interest flows, are projected for each portfolio of financial assets and liabilities, based on contractual terms and other
relevant factors including estimates of prepayments and defaults. The aggregate principal balances and interest cash flows for the
respective portfolios form the basis for identifying the notional amount subject to interest rate risk that is designated under cash flow
hedge accounting.
Gains and losses on the effective portions of derivatives designated under cash flow hedge accounting are recognised in Shareholders’
equity. Interest cash flows on these derivatives are recognised in the profit and loss account in interest income consistent with the manner
in which the forecast cash flows affect net result. The gains and losses on ineffective portions of such derivatives are recognised
immediately in the profit and loss account.
For the year ended 31 December 2008, ING Group recognised EUR 746 million (2007: EUR –925 million) after tax in equity as effective
fair value changes on derivatives under cash flow hedge accounting. As a consequence, the balance of the cash flow hedge reserve in
equity as at 31 December 2008 was EUR 1,457 million (2007: EUR 574 million) gross and EUR 1,177 million (2007: EUR 431 million) after
deferred tax. This cash flow hedge reserve will fluctuate with the fair value changes of the underlying derivatives and will be reflected in
the profit and loss account under Interest income/expense over the remaining term of the underlying hedged items. The cash flow hedge
reserve relates to a large number of derivatives and hedged items with varying maturities, up to 40 years for insurance operations and
21 years for banking operations, with the largest concentrations in the range of 20 to 30 years and 35 to 40 years for insurance
operations and 1 to 15 years for banking operations. Accounting ineffectiveness on derivatives designated under cash flow hedge
accounting of EUR 22 million (2007: EUR –9 million) was recognised in the profit and loss account.