Implementation of IAS 36 by Swedish Banks : Interest Rate Swaps in Hedging Applications

In 2005, all groups listed on European stock exchanges are required to prepare their consolidated financial statements according to International Financial Reporting Standards (IFRS). IFRS are different from local regulations across Europe in many aspects, and observers expect the transition process thorny and resource-draining for the companies that undertake it.

The study explores transition difficulties by Swedish bank groups on the way of implementing IAS 39, Financial Instruments: Recognition and Measurement. Deemed the most controversial and challenging standard for adoption by the financial sector, it indeed poses new demandson classification, recognition and measurment of financial instruments, and sets out new hedge accounting rules, previously unseen in Swedish practice. Additionaly, the structure of bank's balance sheets makes IAS 39 also the central one among all other standards in terms of numbers of balance sheet items it impacts.

The study uses qualitative method to explore whether transition to IAS 39 is likely to improve transparency in reporting derivatives. Focus is on use of interest rate swaps as hedging instruments in mitigation of interest rate risk.

It is concluded that differences between two reporting frameworks have been well understood by the banks early in the implementation process. A negative feature of the standard is increased volatility in earnings as a result of more wide-spread reliance on fair value measurement method. This accounting volatility impedes comparability of performance results, as well as conceals true efficiency of economic hedge relationships. To some degree, the volatility can be minimized by the application of hedge accounting. However, a bank must methodically follow a set of rigourous if hegde accounting is to be adopted. Fair value is a more straightforward alternative to hedge accounting , but it brings in additional concerns, and has not yet been endorsed in the EU.

It is additionally argued that recognition of all derivatives on BS and measurement at fair value are two important features of IAS 39 that indeed increases reporting transparency by minimizing risk of undisclosed hidden losses.