35.1 Accounting policy

Derivatives include financial instruments held for trading as well as financial instruments constituting a hedge of fair value or cash flows.

Derivative financial instruments held for trading are recognized at fair value on the transaction date and subsequently measured at fair value in accordance with the rules described in section 9.1.4.

Derivatives are recognized as financial assets if their fair value is positive or as financial liabilities if it is negative.

Changes of fair value of derivatives that are not hedges are recognized under “Net movement in fair value of assets and liabilities measured at fair value”.

As at 31 December 2020, PZU Group companies were not parties to agreements including embedded derivatives whose character and related risks were not closely linked to the base agreement.

The PZU Group took advantage of the option available in IFRS 9 and continues to apply hedge accounting in accordance with IAS 39.

Hedge accounting recognizes is used to recognize the offsetting effects on profit or loss of changes in the fair values of the hedging instrument and the hedged item. Hedge accounting is applied if the following conditions are fulfilled:

• at the inception of the hedge there is formal designation and documentation of the hedging relationship and the risk management objective and strategy for undertaking the hedge. The documentation includes identification of the hedging instrument, the hedged item, the nature of the risk being hedged and how the entity will assess the hedging instrument’s effectiveness;
• the hedge is expected to be highly effective in achieving offsetting changes in fair value or cash flows, consistently with the originally documented risk management strategy for that particular hedging relationship;
• in the case of cash flows it is highly probable that a hedged transaction occurs that is exposed to changes in cash flows affecting the profit and loss account;
• the effectiveness of the hedge can be reliably measured, i.e. the cash flows of the hedged item and the fair value of the hedging instrument can be reliably measured;
• The hedge is assessed on an ongoing basis and determined actually to have been highly effective throughout the financial reporting periods for which the hedge was designated.

The PZU Group ceases to apply hedge accounting if the hedging instrument expires or is sold, terminated or exercised (for this purpose, the replacement or rollover of a hedging instrument into another hedging instrument is not an expiration or termination if such replacement or rollover is part of the hedging strategy), if the hedge no longer meets the hedge accounting criteria or the hedging designation is revoked.

Evaluation of the impact of the IBOR reform on hedge accounting

The PZU Group intends to continue the established hedging relationships in hedge accounting, despite:

• the uncertainty regarding the amount and timing of the cash flows as a result of the IBOR reform in cash flow hedge accounting,
• the uncertainty regarding the possibility of unambiguous identification and replacement of the benchmark in hedged and hedging instruments as part of fair value hedge accounting.

As part of the established hedging relationships, the PZU Group identifies the following interest rate reference rates: WIBOR, EURIBOR, LIBOR CHF, LIBOR USD. As at 31 December 2020 the aforementioned reference rates are quoted daily and available for application, and the resulting cash flows are normally exchanged with the counterparties.

The Group assessed that in the case of WIBOR and EURIBOR there is currently no uncertainty regarding the dates or amounts of cash flows resulting from the IBOR reform. Both indicators went through the reform and are prepared by administrators holding authorizations in accordance with the European Union’s benchmark regulation (BMR Regulation). The PZU Group does not expect it will be necessary to change the hedged risk for other benchmarks.

In the case of LIBOR CHF and LIBOR USD, the established hedging relationships exceed the announced dates for discontinuation of both benchmarks, i.e. 31 December 2021 for LIBOR CHF and 20 June 2023 for LIBOR USD. The PZU Group expects that these benchmarks will be replaced by new reference indicators: LIBOR CHF by SARON (Swiss Averaged Rate Overnight) administered by SIX Swiss Exchange and LIBOR USD by SOFR (Secured Overnight Financing Rate) administered by Federal Reserve Bank of New York, but there is uncertainty regarding the dates and cash flow amounts for the new indicators. Such uncertainty may influence the assessments of the effectiveness of the relationship and high probability of the hedged position. For the needs of these assessments the PZU Group assumes that the interest rate benchmarks on which cash flows from the hedged position or hedging instrument will not change as a result of the IBOR reform.

The PZU Group has devised an action plan for the eventuality of material changes or discontinuation of preparation of a benchmark. One of these actions in the plan is to introduce appropriate clauses in the agreements with the counterparties. As regards hedging instruments the PZU Group actively cooperates with the counterparties to introduce rules of conduct consistent with the ISDA (ISDA Fallbacks Protocol) methodology.