Power Purchase Agreements & IFRS 9 amendments

The proposed amendments are narrowly-scoped to address only renewable electricity contracts for which:

1. the source for production of the renewable electricity is nature-dependant such that supply cannot be guaranteed at particular times or in particular volumes. Examples are wind-, solar- and hydro-electricity.
2. volume (i.e., production) risk is substantially transferred to the purchaser, also referred to as pay-as-produced features. Volume risk is the risk that the timing or volumes of electricity supplied do not necessarily align with the purchaser’s demand.

The proposals also recommend that the accounting for Renewable Energy Certificates (RECs) is excluded from this project.

For the purposes of applying the own use requirements in paragraph 2.4 of IFRS 9 to a contract to purchase renewable electricity within the scope of the project, the proposed amendment requires the purchaser to consider:

1. the purpose, design and structure of the contract, and whether the volumes expected to be delivered under the contract continue to be consistent with the purchaser’s expected purchases or usage requirements for the remaining life of the contract; and
2. the reasons for past sales of unused renewable electricity and whether such sales are consistent with the purchaser’s expected purchases or usage requirements. Sales would be consistent with the purchaser’s expected purchase or usage requirements if those sales arose from:
   • mismatches between the renewable electricity delivered and the purchaser’s demand requirements at the time of delivery; and
   • the design and operation of the market within which the renewable electricity is transacted that prevents the purchaser from having the practical ability to determine the timing or price of such sales.

The amendments to hedge accounting requirements are only proposed for IFRS 9. Entities applying hedge accounting requirements under IAS 39 would not be within the scope of the proposed amendments given the differences in requirements, especially the restrictions around hedging of risk components of non-financial items and the more prescriptive hedge effectiveness requirements under IAS 39.

Unlike most other forecast transactions where cash flow variability only arises because of price uncertainty, in a contract for renewable electricity cash flow variability arises because of both price and volume uncertainty.

The proposed amendments to the hedge accounting requirements under IFRS 9 recommend that when designating a cash flow hedging relationship in which a contract for renewable electricity (falling within the narrow scope definition set out above) is designated as a hedging instrument, an entity is permitted to designate as the hedged item a variable nominal volume/quantity of forecasted sales or purchases of renewable electricity if, and only if: 

1. the volume of the hedged item designated is specified as a proportion of the variable volume of the hedging instrument.
2. the hedged item is measured using the same volume assumptions as those used for the hedging instrument. However, all other assumptions used for measuring the hedged item, are reflective of the nature of the hedged item and do not impute the features of the hedging instrument (for example the pricing structure).
3. the designated forecasted sales or purchases of electricity are:
   • for a purchaser, highly probable if the entity has sufficient highly probable capacity that exceeds the estimated variable volume/quantity to be designated in the hedged item; or
   • for a seller, not required to be highly probable because the designated quantity of sales is certain to occur once produced.

The proposals analyse the above requirements from the perspective of a seller of electricity and a purchaser of electricity.

For a seller of electricity, the current challenge in hedge accounting arises as a result of the highly probable criterion where the hedged item is required to be defined with sufficient specificity in terms of its volume and timing of occurrence. For a hedging instrument, where the volumes are variable, ineffectiveness arises from comparing an instrument with a variable volume against a hedged item with a static volume.

The proposed amendments, in recommending that the volume of the hedged item may be specified as a proportion of the variable volume of the hedging instrument, attempts to address the volume risk while still capturing the impact of the ineffectiveness from other sources such as timing mismatches and differences between expected and actual volumes of energy produced.

For a purchaser of electricity, the current challenge in hedge accounting arises because the volume of forecast purchases does not vary in accordance with the volume of electricity produced on which net settlement is required under the virtual PPA.

The proposed amendments therefore recommend that the volume of the hedged item may be specified as a proportion of the variable volume of the hedging instrument as long as the variable volume is highly probable. The proposed amendments attempt to address the volume variability while still capturing the impact of the ineffectiveness from other sources such as timing, basis risk and where actual volumes are different to expected.

All other qualifying criteria for hedge accounting under IFRS 9 continue to apply, such as: the requirements that the hedging relationship consists only of eligible hedging instruments and eligible hedged items; that there is formal designation in place at the inception of the hedging relationship; and that the hedging relationship meets all the hedge effectiveness requirements.

For the proposed disclosures, with respect to the contracts for renewable electricity within the narrow-scope of the amendments, the proposals recommend that an entity is required:

1. to disclose information that enable investors to assess the effects of the contracts:
   • on an entity’s financial performance; and
   • on the amount, timing and uncertainty of the entity’s future cash flows.
2. to disclose for all its contracts:
   • the terms and conditions of contracts. For example, the term, the type of pricing including price adjustment clauses, minimum or maximum quantities, cancellation clauses and inclusion of RECs.
   • either the fair value at the reporting date, accompanied by the information required by paragraphs 93(g)–93(h) of IFRS 13 for fair value measurements categorised within Level 3, or the items of information listed in paragraph (c).
3. if that entity does not disclose the fair value of its contracts for renewable electricity applying paragraph (b)(ii), to disclose for these contracts:
   • the total volume of renewable electricity sold or purchased under the contracts during the reporting period.
   • the average market/spot price per unit of electricity for the reporting period.
   • the volume of renewable electricity an entity expects to sell or purchase over the remaining term of the contracts.
   • the methods and assumptions used in preparing the analysis in (iii), including information about changes from the previous period in the methods and assumptions used, and the reasons for such changes.

1. to apply the proposed amendments to the own-use requirements retrospectively applying IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, but the entity is not required to restate prior periods. Any difference between the previous carrying amount and the carrying amount at the beginning of the annual reporting period that includes the date of initial application (“Initial application period”) shall be recognised in the opening retained earnings (or other component of equity, as appropriate) of the Initial application period. An entity may restate prior periods only if it is possible to do so without the use of hindsight.
2. to apply the proposed amendments to the hedge-accounting requirements prospectively. However, during the Initial application period, an entity is permitted:
   • for hedging relationships that are already designated, to alter the designation of the hedged item without resulting in the discontinuation of the hedging relationship.
   • for potential hedging relationships that would have met the qualifying hedge accounting criteria if the proposed amendments are available at that time, designate the hedging relationship from the date the criteria would have been met.
3. for the transition requirements described in paragraphs (b)(i) and (b)(ii), requires that such designations can be made if, and only if, the entity do so without the use of hindsight and the formal documentation of the hedging relationship is in place by the end of the Initial application period. This means that an entity needs to have the required information available from the date on which the entity would be designating the hedging relationship.
4. exempts an entity from disclosing, for the current period and for each prior period presented, the quantitative information as required by paragraph 28(f) of IAS 8.
5. permits early application of the proposed amendments and requires an entity that applies the amendments early to disclose that fact.
6. does not provide transition relief for first-time adopters