The manner in which the Federation assesses market risks as well as the objectives, policies and methods it uses to manage them are presented in Section 4.0, “Risk Management”, of the Management’s Discussion and Analysis.
Fair value hedges
Fair value hedge transactions involve mostly the use of interest rate swaps to hedge the changes in fair value of a fixed-rate financial instrument caused by a change in interest rates on the market. In addition, when a financial instrument is denominated in a foreign currency, the Federation may enter into fair value hedges by using currency swaps or cross-currency interest rate swaps. The change in fair value of hedging derivative financial instruments offsets the change in fair value of hedged items. The Federation uses fair value hedge strategies for its loan, deposit and securities portfolios.
Cash flow hedges
Cash flow hedge transactions involve mostly the use of interest rate swaps to hedge the changes in future cash flows from a floating-rate financial instrument. Hedging derivative financial instruments reduce the variability of future cash flows from the hedged item. The Federation uses cash flow hedge strategies for its loan, deposit and securities portfolios.
Effectiveness assessment and sources of hedging relationship ineffectiveness
The Federation assesses the effectiveness of a hedging relationship by comparing the change in fair value or cash flows of the hedging instrument with that of the hedged item attributable to the hedged risk to demonstrate the existence of a highly effective correlation between the two instruments. When derivative financial instruments are designated as hedging instruments for a currency risk, only the change in currency risk is taken into account to assess hedge effectiveness.
There is ineffectiveness when the change in fair value of the hedged item attributable to the hedged risk differs from the change in fair value of the hedging instrument. The main sources of ineffectiveness are a difference between the actual and expected repricing dates, a difference between the discounting factors used and a difference between the payment dates for the hedging instrument and the hedged item.
The following table presents information on the ineffectiveness of fair value hedges.
As at As at
December 31, 2020 December 31, 2019
Gains (losses) Gains (losses)
on hedging on hedging
instruments used Hedge instruments used Hedge as the basis for ineffectiveness as the basis for ineffectiveness calculating hedge recognized in calculating hedge recognized in
ineffectiveness profit or loss(1) ineffectiveness profit or loss(1)
Fair value hedges
Interest rate contracts / Interest rate risk
Over-the-counter interest rate swaps $ 320 $ 2 $ 125 $ -
Interest rate swaps traded through a clearing house 59 (3) - -
Foreign exchange contracts / Currency risk
Over-the-counter currency swaps 217 (23) (786) 1
Total – Fair value hedges $ 596 $ (24) $ (661) $ 1
(1) The hedge ineffectiveness and reclassification adjustment are recognized under "Net investment income".
NOTE 20 – DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (continued)
HEDGING ACTIVITIES (continued)
Effectiveness assessment and sources of hedging relationship ineffectiveness (continued)
The following tables present information on the ineffectiveness of cash flow hedges for the years ended December 31.
Gains (losses) reclassified from the cash flow hedge reserve
into profit or loss
Gains (losses) on Hedging
hedging instruments Hedge gains (losses) used as the basis for ineffectiveness recognized in other
calculating hedge recognized in comprehensive
2020 ineffectiveness profit or loss(1) income Active hedges(2)
Cash flow hedges
Interest rate contracts / Interest rate risk
Over-the-counter interest rate swaps $ 152 $ 2 $ 33 $ 13
Interest rate swaps traded through
a clearing house 11 - (4) (9)
Total – Cash flow hedges $ 163 $ 2 $ 29 $ 4
(1) The hedge ineffectiveness and reclassification adjustment are recognized under ''Net investment income''.
(2) The reclassification adjustment is included under “Interest income – Loans” and “Interest expense – Deposits”.
Gains (losses) reclassified from the cash flow hedge reserve
into profit or loss
Gains (losses) on Hedging
hedging instruments Hedge gains (losses) used as the basis for ineffectiveness recognized in other
calculating hedge recognized in comprehensive Active
2019 ineffectiveness profit or loss(1) income hedges(2)
Cash flow hedges
Interest rate contracts / Interest rate risk
Over-the-counter interest rate swaps $ (11) $ - $ (9) $ 3
Total – Cash flow hedges $ (11) $ - $ (9) $ 3
(1) The hedge ineffectiveness and reclassification adjustment are recognized under ''Net investment income''.
(2) The reclassification adjustment is included under “Interest income – Loans” and “Interest expense – Deposits”.
HEDGING ACTIVITIES (continued)
Effectiveness assessment and sources of hedging relationship ineffectiveness (continued)
The following tables present the impact of hedge accounting on balances recognized in the Consolidated Balance Sheets and in accumulated other comprehensive income.
Cash flow hedges Fair value hedges
Accumulated
amount
of fair Accumulated
Gains value hedge amount Gains
(losses) on adjustments of fair (losses) on
hedged items on the value hedge hedged items
used as the hedged item adjustments used as the
basis for included in for basis for
Balance Balance of the calculating Carrying the carrying any hedged calculating of the cash reserve for hedge amount of amount of items that hedge flow hedge discontinued ineffectiveness the hedged the hedged have ceased ineffectiveness As at December 31, 2020 reserve hedges for the year item item to be adjusted for the year Interest rate risk
Assets
Securities $ 9 $ 7 $ (13) $ 23,368 $ - $ - $ 26
Loans 19 9 (182) 1,337 32 1 40
Liabilities
Deposits $ (8) $ (21) $ 34 $ 11,630 $ (374) $ (45) $ (445)
Currency risk Liabilities
Deposits $ - $ - $ - $ 9,082 $ (151) $ - $ (240)
Cash flow hedges Fair value hedges
Accumulated amount
of fair Accumulated
Gains value hedge amount Gains
(losses) on adjustments of fair (losses) on
hedged items on the value hedge hedged items
used as the hedged item adjustments used as the
basis for included in for basis for
Balance Balance of the calculating Carrying the carrying any hedged calculating
of the cash reserve for hedge amount of amount of items that hedge
flow hedge discontinued ineffectiveness the hedged the hedged have ceased ineffectiveness
As at December 31, 2019 reserve hedges for the year item item to be adjusted for the year
Interest rate risk Assets
Securities $ 2 $ - $ 6 $ 2,382 $ - $ - $ (18)
Loans (17) (1) 12 1,349 (1) - 12
Liabilities
Deposits $ 2 $ (4) $ 1 $ 12,246 $ (14) $ (4) $ (119)
Currency risk Liabilities
Deposits $ - $ - $ - $ 11,488 $ 40 $ - $ 787
NOTE 20 – DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES (continued)