Potential sources of ineffectiveness can be attributed to the differences between hedging instruments and the hedged items:
• Mismatches in terms of hedged item and hedging instrument, such as the repricing dates and frequency of payments • The effect of the counterparty and our own credit risk
Interest income received or interest expense paid on derivative financial instruments designated as cash flow hedges is accounted for on the accrual basis and recognized as interest expense over the term of the hedge contract. Premiums on purchased contracts are amortized to interest expense over the term of the contract. Accrued interest receivable and payable and deferred gains and losses for these contracts are recorded in other assets or liabilities as appropriate. When a hedging instrument expires or is sold, or when a hedge no longer meets the criteria for hedge accounting, any cumulative gain or loss existing in other comprehensive income at that time is held separately in accumulated other comprehensive income until the forecast transaction is eventually recognized in the consolidated statements of income. When a forecast transaction is no longer expected to occur, the cumulative gain or loss that was reported in accumulated other comprehensive income is immediately reclassified to the consolidated statements of income. INTEREST RATE RISK Interest rate risk arises when changes in interest rates affect the cash flows, earnings and values of assets and liabilities. Under our interest rate risk management policies, we maintain an appropriate balance between earnings volatility and economic value volatility while keeping both within their respective risk appetite limits. Exposure to interest rate risk is controlled by managing the size of the static gap positions between interest sensitive assets and interest sensitive liabilities for future periods. This is achieved partly by using interest rate swaps and bond forward contracts as a hedge to interest rate changes.
Only the changes in fair value and cash flows related to changes in benchmark interest rates are designated as hedges for accounting purposes. Other risk elements present in these relationships, such as credit risk, have a less significant impact on changes in fair value and cash flows, and are not designated as accounting hedges.
The hedging ratio is established by matching the notional amount of the hedging instrument with the notional amount of the hedged item. The existence of an economic relationship between the hedging instrument and hedged item is based on the reference interest rates, tenors, repricing dates and maturities, and the notional or par amounts.
EQUITY RISK Equity risk arises when changes in our common share price affects the payout of share-based payment plans (see Note 16) that have not yet vested. We have a policy to hedge a portion of the earnings volatility related to restricted share unit (RSU) and deferred share unit (DSU) grants through the use of equity swaps, where we make periodic interest payments to a counterparty and receive the capital gain or loss plus dividends of a CWB common share.
The following table shows the derivative financial instruments split between those contracts that have a positive fair value (favourable contracts) and those that have a negative fair value (unfavourable contracts):
As at October 31, 2023
As at October 31, 2022
Favourable Contracts
Unfavourable Contracts
Favourable Contracts
Unfavourable Contracts
Notional Amount
Notional Amount
Notional Amount
Notional Amount
Fair Value
Fair Value
Fair Value
Fair Value
Cash Flow Hedges Interest rate risk
Interest rate swaps
$ 1,445,000 $
84,993 $ 7,170,000 $
(179,809) $ 1,135,000 $
83,465 $ 4,935,000 $
(151,084)
Equity risk
Equity swaps
11,520
1,451
9,822
(552)
3,522
100
16,234
(3,776)
Fair Value Hedges Interest rate risk
Interest rate swaps
339,616
21,758
-
-
355,020
26,950
-
-
Not Designated as Accounting Hedges
Foreign exchange contracts
41,628
4
745,443
(18,235)
144
6
-
-
Equity swaps
7,677
1,084
-
-
-
-
8,066
(1,221)
Total
$ 1,845,441 $
109,290 $ 7,925,265 $
(198,596) $ 1,493,686 $
110,521 $ 4,959,300 $
(156,081)
The aggregate contractual or notional amount of the derivative financial instruments on hand, the extent to which instruments are favourable or unfavourable and, thus, the aggregate fair values of these financial assets and liabilities can fluctuate significantly from time to time.
The average fair values of the derivative financial instruments on hand during the year are set out in the following table:
2023
2022
Favourable derivative financial instruments (assets)
$
106,712
$
83,371
Unfavourable derivative financial instruments (liabilities)
$
165,262
$
89,040
CWB Financial Group 2023 Annual Report | 87
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