Hedge Ratio and Rebalancing under Ind AS 109

The hedge ratio is one of the most practical links between an entity's risk management activity and its hedge accounting. It describes the relationship between the quantity of the hedging instrument and the quantity of the hedged item included in the designated relationship. Under Ind AS 109, that ratio should reflect how the entity actually manages the risk, while avoiding deliberate imbalance that would distort the accounting outcome.

Because market conditions and exposure characteristics can change, the standard also provides for rebalancing. Rebalancing allows an entity to adjust the designated quantities when necessary to restore an appropriate hedge ratio without automatically terminating an otherwise continuing hedge relationship.

Hedge ratio is not always 1:1

If an entity expects to buy USD 1 million and uses a USD 1 million forward with matching maturity, the nominal relationship may be straightforward.

Other risks are less exact. A company may hedge the price of a physical commodity using a futures contract based on a related but not identical grade or location. One futures unit may not produce the same sensitivity as one unit of the physical exposure. Similarly, an interest-rate derivative and a debt instrument can have different repricing characteristics.

In such cases, the risk management function may use a ratio that reflects relative sensitivities rather than identical nominal amounts. The accounting hedge ratio should generally follow that genuine risk management quantity relationship, assuming the designation does not create an imbalance inconsistent with the purpose of hedge accounting.

Why deliberate imbalance is prohibited

Imagine that risk management actually hedges 100 units of exposure with 90 units of a derivative. If the accounting designation selectively treats only 70 units of the exposure as hedged solely because that quantity produces a more attractive accounting result, the designation may not reflect the real relationship.

Ind AS 109 is designed to align accounting with risk management, not to provide a mechanism for engineering hedge ineffectiveness. The chosen ratio should therefore have an economic basis. The file should explain why the quantities were selected and how they relate to the entity's approved risk limits or hedging strategy.

When can the ratio become inappropriate?

The hedge ratio can become inappropriate even though the risk management objective has not changed. Basis relationships may evolve. Relative price sensitivities can shift. A forecast volume may be revised. The characteristics of the hedged item or instrument may change in a way that affects the expected offset.

Suppose a company hedges a jet-fuel exposure with crude-oil derivatives because the prices have a stable economic relationship. If the relative pricing relationship changes significantly, the quantity of crude-oil derivatives needed to hedge a given volume of jet fuel may change. The original accounting ratio may then create systematic ineffectiveness.

The entity should assess whether the change is temporary noise, a fundamental break in the economic relationship, or a change that can be addressed by rebalancing.

What is rebalancing?

Rebalancing is an adjustment to the designated quantities of the hedged item or hedging instrument in an existing hedging relationship so that the hedge ratio again meets the qualifying criteria. It is treated as a continuation of the hedge relationship, not as an automatic discontinuation and new designation.

That distinction matters. If every change in ratio required the entity to terminate and restart hedge accounting, the accounting would be less aligned with dynamic risk management. Rebalancing provides a controlled way to update the accounting designation while the underlying risk management objective continues.

Rebalancing can involve increasing or decreasing the quantity of the hedged item included in the relationship, changing the quantity of the hedging instrument included, or a combination of the two. Any portion removed from the relationship is dealt with under the applicable hedge accounting requirements.

Rebalancing is not a cure for every problem

Rebalancing assumes that the risk management objective for the relationship remains the same and that the relationship can continue to meet the qualifying criteria after the adjustment. It cannot repair a situation where the economic relationship has disappeared or where the risk management objective itself has changed fundamentally.

It also does not erase hedge ineffectiveness already recognised. Before changing the ratio, the entity measures and recognises hedge ineffectiveness for the period based on the existing designation as required. The rebalanced relationship then operates prospectively.

A simplified example

Assume an entity designates 100 units of a commodity exposure with 100 units of a related futures contract. Over time, analysis shows that changes in the futures price now produce approximately 1.10 times the response of the physical exposure because the basis relationship has shifted.

If risk management adjusts the quantity of futures used to manage the same exposure, the accounting team should evaluate whether the hedge ratio should be rebalanced to reflect the revised relationship. ## Documentation for a rebalancing decision

A strong rebalancing memo answers four questions. What changed in the relationship? Why does the original ratio no longer appropriately reflect the relationship? Does the risk management objective remain unchanged? What new quantity relationship is being used and why?

Attach the quantitative evidence, approvals and any updated derivative or exposure records. Record the effective date of rebalancing and reconcile the quantities removed from or added to the designated relationship.

The hedge designation document should be updated without rewriting history. Reviewers should be able to see the original designation, the trigger for rebalancing, the revised ratio and the accounting effects.

Monitor ratios as part of the close process

Rebalancing works best when it is built into the normal hedge-monitoring cycle rather than discovered after year-end. A dashboard can flag changes in basis, forecast volume, sensitivity or critical terms that could make the existing ratio inappropriate.

The key is to treat the hedge ratio as a living representation of risk management. When the economics move but the objective remains, rebalancing can preserve continuity. When the objective or qualifying relationship has ended, discontinuation may be required instead. That disciplined distinction is essential to applying Ind AS 109 correctly.