LETTER OF NATIONAL BANK OF THE REPUBLIC OF KAZAKHSTAN

of December 21, 2006 No. 24129/2735

Present the Accounting department of National Bank of the Republic of Kazakhstan sends you for data and use in work methodical recommendations about reflection in financial accounting of banks of the second level of transactions of hedging.

Methodical recommendations about reflection in financial accounting of banks of the second level of transactions of hedging

According to Item 9 of the International accounting standard No. 39 "Financial instruments - recognition and assessment" (further - IFRS 39), the hedging instrument is certain derivative tool or (in relation to hedging of risk of changes only of the currency exchange rates) certain non-productive financial asset or the non-productive financial liability, fair value or cash flows of which, as expected, will compensate changes of fair value or cash flows of a certain hedged Article. The hedged Article is asset, the obligation, the firm agreement, the high-probable predicted transaction or net investment in foreign activities in connection with which (a) the organization is exposed to risk of changes of fair value or future cash flows and (b) which is determined as hedged. Efficiency of hedging is degree in which belonging to the hedged risk of change of fair value or cash flows of the hedged Article are compensated by changes of fair value or cash flows of hedging instrument.

Accounting and reflection of transactions of hedging, and also income/expenses on them, in the financial reporting of Bank it is necessary to perform according to IFRS 39.

IFRS 39 allocate three types of the relations of hedging (hedging of fair value; cash flow hedging; hedging of net investments in the foreign organization) and for each of them establishes separate requirements for accounting.

It should be noted that IFRS 39 establish certain requirements for the purpose of differentiation of concept of the hedged tool and the derivative financial instrument. Use of the relation of hedging during the incomplete cycle time of hedging instrument is not allowed. Thus, availability between hedging instrument and the hedged Article of the relation of hedging can be determined only when all following conditions are satisfied:

a) from the very beginning of the relations of hedging of task of the organization in the field of risk management and the strategy of hedging are stated in the official documentation. In this documentation the hedging instrument is determined, the related hedged Article or the transaction, nature of the hedged risk, and also is established how the organization will estimate efficiency of hedging instrument from the point of view of compensation of risk of changes of fair value or cash flows of the hedged Article;

b) it is meant that hedging will be highly effective (in the range from 80 to 125 percent) and will provide compensation connected with the hedged risk of changes of fair value or cash flows according to the strategy of risk management which is initially formulated for this specific relation of hedging;

c) in case of cash flow hedging the high probability of making of the expected transaction which is subject to hedging to which the risk of changes of the cash flows influencing finally net profit or loss shall accompany is necessary;

d) efficiency of hedging can be reliably estimated, i.e. the fair value or cash flows of the hedged Article connected with the hedged risk, and fair value of hedging instrument can be authentically determined;

e) assessment of hedging was carried out on permanent basis therefore its outstanding performance throughout the entire periods of the financial reporting for which it was intended was established.

Thus, accounting of hedging of fair value needs to be performed as follows:

1) the income and expenses from revaluation of hedging instrument at fair value should be carried on the income and expenses;

2) book value of the hedged Article shall be adjusted taking into account referred to the hedged risk of profit or loss under the hedged Article, and these the profit or loss should be reflected in profits and loss accounts. It belongs to those cases when assessment of the hedged Article is carried out on actual costs. Profit or loss, referred to the hedged risk, are recognized on the profit and loss account if the hedged Article is the financial asset, available for sale.

To accounting of cash flow hedging the following requirements are established:

1) part of profit or loss on hedging instrument which efficiency was established should be carried directly on accounts of the capital through the statement of changes in equity;

2) the inefficient part of profit or loss on hedging instrument is subject to reflection on the profit and loss account.

It is necessary to consider hedging of net investments in foreign transactions the same as cash flow hedging.

Income/expenses on hedging instrument belongs on the separate personal account opened on the balance sheet account of income/expenses under the relevant hedged article.

IFRS 39 require carrying out two types of tests of efficiency of hedging:

 expected (prospective): testing regarding whether there will be hedging relation highly effective in future periods. This test is required to be carried out at least at the time of the beginning of the relations of hedging and for date of preparation by the organization of the intermediate or annual financial reporting.

 retrospective (retrospective): hedging relation efficiency evaluation based on the actual indicators. This test is required to be carried out, at least, for each date of preparation by the organization of the intermediate or annual financial reporting.

The accounting treatment when hedging is applied by the organization on condition of carrying out both above-stated tests.

IFRS 39 do not establish only sure method of carrying out the expected or retrospective efficiency evaluation of hedging. The method applied by the organization depends on the accepted strategy of risk management and shall be described in the official documentation from the very beginning of the hedging relations. The most widespread methods is the following:

 comparison of emergency conditions (critical terms comparison): the method consists of comparison of so-called emergency conditions of hedging instrument and the hedged Article, such as, the conditional amount of hedging instrument and the amount of principal debt of the hedged Article, credit risk (VV), term, dates of assessment and revaluation, date, the amount and currencies of cash flows;

 method of dollar offset (dollar offset method): quantitative method in case of which are compared change in fair value or cash flows of hedging instrument to change in fair value or cash flows of the hedged Article. Depending on policy of the organization for risk management the test can be carried out or on cumulative basis (from the very beginning of hedging), or only for the accounting period (comparison is made, since the last date of the test);

 the recourse analysis (regression analysis) is the statistical technique determining force of statistical communication between the hedged Article and hedging instrument.

The accounting treatment for hedging provided by IFRS 39 shall be stopped if:

 hedging does not take test for efficiency (is beyond 80-125%);

 the hedged Article is sold or extinguished;

 the hedging instrument is sold, stopped or used;

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