29. Hedge accounting

The Group applies hedge accounting to hedge its interest rate risk and foreign exchange risk. The hedging transactions are concluded to mitigate the risk of incurring losses as a result of unfavourable changes in foreign currency exchange rates and interest rates. Cash flows related to the transactions performed and the fair value of assets held are hedged.

The interest rate risk covers in particular:

• the risk related to the repricing (change in interest rates) frequency and dates mismatch of the assets and liabilities, and of off-balance sheet items (repricing date mismatch risk);
• the risk following from the change in the angle of inclination and shape of the yield curve (yield curve risk);
• the risk resulting from an imperfect match between the reference rates used in respect of banking products and the changes in the market rates, or from imperfect transmission systems of changes in market interest rates on those products (base risk);
• risks resulting from options, including embedded options, e.g. restrictions on interests on loans (option risk).

The Group’s foreign exchange risk arises as a result of transactions performed under:

• core business activities;
• trading activities;
• contracts concluded by the Group which generate foreign exchange risk.

Foreign exchange risk arising from the Group’s activities is managed, where required, by specialized units as part of their own operations based on the data received on open currency positions.

A system of threshold values and limits attributed to particular interest and foreign exchange risks is in force at the Group, aimed at determining the maximum allowable risk level which ensures that the strategic tolerance limits are not exceeded.

The Group decided to further apply the provisions of IAS 39 and did not apply IFRS 9 in respect of hedge accounting.

Changes in the fair value of a derivative financial instrument designated as a cash flow hedge are recognized directly in other comprehensive income in respect of the portion constituting the effective portion of the hedge. The ineffective portion of a hedge is recognized in the income statement in the item “Gains/(losses) on financial transactions” or “Foreign exchange gains (losses)”.

Amounts transferred directly to other comprehensive income are transferred to the income statement in the same period or periods in which the hedged planned transaction affects the income statement. Interest and foreign exchange gains/losses are presented in the income statement, in “Net interest income” and “Net foreign exchange gains (losses)”, respectively.

The effectiveness tests comprise the measurement of hedging transactions net of interest accrued and foreign exchange gains (losses) on the nominal value of the hedging transactions (in the case of CIRS transactions).

Hedge effectiveness is verified through the use of prospective and retrospective effectiveness tests. The tests are performed on a monthly basis.

Changes in the fair value of a derivative hedging instrument designated as fair value hedge are recognized in “Gains/(losses) on financial transactions”, net of the interest component. The interest component is presented in the same line item as interest income on the hedged item, i.e. in “Net interest income”.

A change in the fair value adjustment to the hedged item is recognized in “Gains/(losses) on financial transactions”.

The part of the fair value adjustment which is not hedged is recognized:

• for a hedged item which is a financial asset or a financial liability classified as measured at fair value through profit or loss – as income or costs, as appropriate, in gains/(losses) on financial transactions;
• for a hedged item which is a financial asset measured at fair value through other comprehensive income – in other comprehensive income, where the change in the fair value of financial instruments measured at fair value through other comprehensive is presented.

The effectiveness tests comprise the measurement of hedging transactions net of accrued interest.

Hedge effectiveness is verified through the use of prospective and retrospective effectiveness tests. The tests are performed on a monthly basis.

As at 31 December 2020, the Group had had active relationships as part of:

• 6 strategies for hedging cash flow volatility
• 4 strategies for hedging fair value volatility.

In 2020 the Group introduced new hedging strategies:

• • “Hedging fair value volatility of fixed-interest-rate securities in PLN, measured at fair value through other comprehensive income, resulting from the interest rate risk, using IRS transactions”;
  • “Hedging cash flow volatility of floating interest rate convertible currency loans arising from interest rate and foreign exchange risk, as well as hedging cash flow volatility of financial liabilities in convertible currencies arising from foreign exchange risk, using CIRS transactions.”

In 2020, the Group closed two relationships under the hedging strategy “Hedging cash flow volatility of floating interest rate convertible currency loans arising from interest rate and foreign exchange risk, as well as hedging cash flow volatility of fixed interest financial liabilities in convertible currencies arising from foreign exchange risk, using CIRS transactions”, due to having no such hedged items. The total effect of discontinuing to apply hedge accounting as part of these relationships on other comprehensive income amounted to PLN 33 million, and net interest income increased by the same amount.

In 2020, the Group closed, as a result of invalidation, a relationship under the hedging strategy “Hedging the fluctuations in the fair value of fixed-interest-rate securities in PLN, measured at fair value through other comprehensive income, resulting from the interest rate risk, using IRS transactions”; the effect of discontinuation of hedge accounting as part of the said relationship on the profit or loss amounted to PLN (-7.7) million.

In 2020, the Group closed, as a result of failing to pass the prospective test of sufficient nominal amount, a relationship under the hedging strategy “Hedging cash flow volatility of floating interest loans in EUR, resulting from the risk of fluctuations in interest rates, using IRS transactions”. The effect of the discontinuation of hedge accounting as part of the said relationship on the profit or loss amounted to PLN 0.6 million.

In 2020, the Group terminated, as a result of the derecognition of the hedged item, the hedging relationships under the hedging strategies:

• Hedging the volatility of cash flows of floating rate CHF loans, resulting from the risk of changes in interest rates and currency risk, and hedging the volatility of cash flows of term deposits negotiated in PLN, resulting from the risk of changes in interest rates, using CIRS transactions;
• Hedging the volatility of cash flows of loans in convertible currencies with a variable interest rate, resulting from the risk of changes in interest rates and currency risk, and hedging the volatility of cash flows of a financial liability in a convertible currency with a fixed interest rate, resulting from currency risk, using CIRS transactions;
• Hedging the volatility of cash flows of loans in convertible currencies with a variable interest rate, resulting from the risk of changes in interest rates and currency risk, and hedging of the volatility of cash flows of a financial liability in a convertible currency with a fixed interest rate, resulting from currency risk, using transactions: CIRS;
• Hedging the volatility of cash flows of convertible currency loans with a variable interest rate, resulting from the risk of changes in interest rates and currency risk, and hedging the volatility of cash flows of financial liabilities in a convertible currency, resulting from the currency risk, with the use of CIRS transactions.

The total impact of the discontinuation of hedge accounting under the above-mentioned the relationship to other comprehensive income amounted to minus PLN 213 million, with the simultaneous increase in the net interest income and foreign exchange gains/ (losses) by this amount.

No changes were made to other hedging strategies in 2020.

In 2019, the Group introduced two new hedging strategies for fair value hedges.

The tables below summarize the types of strategies applied by the Group.