Contracts for Renewable Electricity (PPAs and VPPAs): IASB publishes exposure draft of proposed amendments to IFRS 9 and IFRS 7

After giving the first broad-brush outline of this project at its March 2024 meeting, on 8 May 2024 the IASB published the exposure draft (ED) of proposed amendments to IFRS 9 and IFRS 7 on contracts for the purchase of renewable electricity (power purchase agreements or PPAs and virtual power purchase agreements or VPPAs). The ED is available here.

The proposed amendments are currently located within Chapter 6 of IFRS 9 on hedge accounting, including those that relate to own-use classification. However, the IASB may relocate the amendments on own-use classification when the final version is published.

The exposure draft was approved by the IASB with a majority of 12 votes out of 14.

Scope (§6.10.1-6.10.2)

The amendments cover both physical power purchase agreements (traditional purchase/sale contracts) and virtual power purchase agreements (which require net settlement of the difference between the contractually agreed price and the market price) that meet the following two criteria:

• production is nature-dependent and cannot be guaranteed for given volumes or over set periods (“risk of intermittency”);
• the purchaser of the electricity is exposed to substantially all of the volume risk (i.e. the risk that the volume of electricity produced will not correspond to its consumption needs at the time of delivery). The exposure to volume risk usually results from i) the risk of intermittency inherent in the production method; ii) the inclusion of “payas-produced” clauses in the contract; and iii) nonlinear consumption.

These two criteria are usually met by renewable energy from wind or solar power, but not by energy produced from biomass and not necessarily by hydroelectric energy, as it is possible to regulate production.

In contrast, renewable energy certificates (RECs) and similar certificates, which often accompany these contracts, are not included within the scope of the amendments. They will be addressed under the IASB’s future project on pollutant pricing mechanisms.

The amendments emphasise the fact that the scope is strictly limited and the rules on own-use classification and hedge accounting may not be applied by analogy to other contracts, items or transactions (para. 6.10.2). Thus, it would not be possible to apply the amendments to contracts for the purchase of non-renewable electricity, or to currency risk hedges that are contingent on a business combination or the success of a call for tenders.

Own-use classification (§6.10.3)

IFRS 9 includes an exception for contracts that were entered into and continue to be held for the purpose of the receipt or delivery of a non-financial item in accordance with the entity’s expected purchase, sale or usage requirements (the so-called “own-use” exception).

In the proposed amendments, classification as “own use” from the buyer’s point of view would be subject to compliance with the following two conditions, considered at inception of the contract and at each subsequent reporting date:

•  the volumes of renewable electricity remaining to be delivered during the residual term of the contract correspond to the purchaser’s expected usage requirements, estimated on the basis of reasonable information available at the reporting date, with no need to make a detailed estimate for periods that are far in the future. However, an entity must consider expected changes over a period not less than one year after the reporting date, or the entity’s normal operating cycle;
• the existence of any (past or future) sales of excess renewable electricity by the consumer does not invalidate the “own-use” classification, provided that:
• the sale arises from the volume risk (as defined in the scope, above), which gives rise to temporary mismatches between production and consumption;
• the design and operation of the market are such that the entity cannot determine the timing or price of such sales;
• the sale is offset by the purchase of at least an equivalent volume of electricity within a “reasonable time”. The IASB cites one month as an example, explaining in the Basis for Conclusions that this example was included to illustrate that a reasonable time is typically a short time. However, should this example be retained in the final amendments, entities with energy consumption profiles that are subject to seasonal constraints could be excluded from the scope.

All these conditions must be met for a PPA to be classified as “own-use”. Otherwise, it would be accounted for as a derivative.

Hedge accounting (§6.10.4 to 6.10.6)

The proposed amendments relate only to IFRS 9, and not the previous standard IAS 39, which can still be applied to hedge accounting.

The amendments relate to the requirements regarding the definition of a hedged item when designating a cash flow hedging relationship where the hedging instrument is:

• a renewable electricity contract within the scope defined above;
• classified as a derivative, because it corresponds either to a virtual PPA (“VPPA”) or to a physical PPA contract that does not qualify as own use (“failed own use”); and
• whose notional amount is variable due to the risk of intermittency.

The ED specifies that in this type of hedging relationship, the hedged item also can be defined as having a variable notional amount if the following conditions are met:

• the hedged item is specified as the variable volume of electricity to which the hedging instrument relates;
• the variable volume hedged does not exceed the estimated volume of future electricity transactions that are highly probable, over the residual duration of the contract. In practice, this criterion will only apply to the purchaser of electricity, with regard to its estimated consumption. From the electricity seller’s point of view, the amendment means that in this situation the “highly probable” criterion need not be applied, if the hedged volumes correspond to all or a proportion of the volumes inherent in the hedging instrument. In fact, in this situation, the volumes defined as hedged items are by nature equal to the volumes underlying the hedging instrument, and therefore application of the “highly probable” criterion is not relevant.

Thus, the hedged item is measured using the same volume assumptions as those used for the hedging instrument. As a result, a VPPA designated as a hedging relationship does not create any ineffectiveness due to variability in the notional volume, from either the buyer or the seller’s point of view. However, the other criteria used to define the hedged item – such as price, timing or the local reference market for supply – cannot replicate those of the hedging instrument, and thus remain potential sources of hedge ineffectiveness.

The effect of the proposed amendments would be to:

• introduce an exception to the principles of the hypothetical derivative method (IFRS 9 B6.5.5), which prohibit the replication on the hedged item of features that only exist in the hedging instrument. If the amendment is confirmed, a purchaser could designate as the hedged item the variable volume of renewable electricity that is produced by the seller’s facility and that is used to calculate the price differentials in the hedging contract;
• introduce an exception to the March 2019 agenda decision on load following swaps (relating to paragraph 6.3.3. of IFRS 9), which prohibits the designation as a hedged item of an exposure with a variable notional amount, due primarily to the constraints imposed by strict application of the concept of “highly probable”.

Disclosure requirements (IFRS 7, §42T-42W)

The proposed disclosure requirements are intended to enable users of financial statements to understand the effects of contracts for renewable electricity on the amount, timing and uncertainty of the entity’s future cash flows.

An entity should disclose the following information for all its contracts for renewable electricity:

• the terms and conditions of the contracts, such as: their duration, their type of pricing (including whether they include price adjustment clauses), minimum or maximum quantities to be delivered, cancellation clauses and whether they include Renewable Energy Credits (RECs);
• for contracts not measured at fair value¹, either:
• the fair value of the contracts at the reporting date, accompanied by the information required by paragraph 93(g)-(h) of IFRS 13²; or
• the following information:

                o   the volume of renewable electricity the entity expects to sell or purchase over the remaining duration of the contracts, broken down by                                    maturity (less than one year; between one and five years; more than five years);

                o   the methods and assumptions used in preparing this information, including any changes since the previous reporting period and the reasons                     for such changes.

In addition, the proposed amendments to IFRS 7 would require the following disclosures for the reporting period:

• for sellers: the proportion of renewable electricity to the total electricity sold;
• for purchasers: 

      o the proportion of renewable electricity to the total volume of electricity purchased;

      o the total net volume of electricity purchased irrespective of the source of production;

      o the average market price per unit of electricity in the markets in which the entity purchased electricity; and

      o if the actual cost of purchasing electricity differed substantially from the hypothetical cost under market conditions (calculated by multiplying the                net volume purchased by the average market price), a qualitative explanation for this difference.

Finally, the ED requires entities to consider the appropriate level of aggregation or disaggregation for presenting these disclosures.

Transition requirements (IFRS 9, §7.2.50 to 7.2.52)

An entity would be required to apply the proposed amendments as follows:

• retrospectively for the own-use requirements, in accordance with IAS 8, without requiring the entity to present comparative information for prior periods. The impacts of the amendments would thus be recognised in opening retained earnings for the first period of application;
• prospectively for the hedge accounting requirements. However, during the period of first application, the entity would be permitted to alter the designation of hedged items in already designated cash hedging relationships, without resulting in discontinuation of the hedging relationship. Although not explicitly stated in the ED, the impacts of the change on the effectiveness calculation would only be prospective, or in other words, it would not be possible to retrospectively restate ineffectiveness recognised prior to the date of initial application as an effective component of the pre-existing hedging relationship;
• The IASB also tentatively decided:
• to exempt an entity from disclosing, for the current period and for each prior period presented, the quantitative information required by paragraph 28(f) of IAS 8;
• to permit early application of the proposed amendments from the date the final amendments are published, provided that this is disclosed.

Effective date

The IASB is planning to publish the final amendments by the end of 2024. The ED asks commenters whether they think an effective date of 1 January 2025 would be appropriate. However, if this date is chosen, it may take until 2025 for the final amendments to be adopted by the European Parliament and Council, which is necessary before they can enter into force in the EU.

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¹ That meet the own use criteria and are not designated under the fair value option

² That is, for Level 3 fair values:

• a description of the valuation processes used by the entity (IFRS 13 para. 93(g))
• a description of the sensitivity of the fair value measurement to changes in unobservable inputs, if a change in the amount of those inputs might result in a significantly higher or lower fair value measurement (IFRS 13 para. 93(h)(i))
• the methods and assumptions used in preparing this information, including any changes since the previous reporting period and the reasons for such changes.