Adoption of Financial VPPAs

A Paradigm Shift: What the IASB Has Changed

Until 2024, companies seeking to apply hedge accounting to a VPPA faced a de facto barrier: the inability to demonstrate hedge effectiveness under the criteria required by IFRS 9 in its original formulation. The variability of renewable generation, the mismatch between consumption and generation timings, and the challenge of defining a “highly probable forecast transaction” with sufficient precision often rendered the cash flow hedge route impractical.

The amendment issued by the IASB in December 2024 represents a significant shift in this landscape.

What the Previous Standard Required

Under the pre-amendment framework:

• The hedged item had to be a highly probable future transaction (e.g. forecast energy purchases);
• There needed to be temporal alignment between the hedging instrument and the underlying exposure;
• Hedge effectiveness had to fall within a 80–125% range, both prospectively and retrospectively;
• Any discrepancy between the production profile and the consumption profile could result in hedge ineffectiveness — and ultimately, disqualification from hedge accounting treatment.

What the Amendment Introduces

The revised approach, which becomes mandatory from 1 January 2026 (with optional early adoption), introduces significantly more flexibility and a framework that better reflects operational reality. Specifically:

• It is now possible to designate as the hedged item a component of the energy price (e.g. PEAK hours in a specific market zone), even when generation volumes are variable;
  
• It is no longer necessary to demonstrate a perfect match between generation and consumption;
  
• The use of forecasting models to estimate volumes is permitted, provided that assumptions are well-reasoned and documented;
  
• The focus shifts from physical delivery and timing to exposure to price risk, enabling a more faithful representation of the economic substance of the hedge.

For example, a manufacturing company that consumes energy primarily during night hours — and thus outside the production window of a solar plant — should now be able to designate a portion of its exposure to electricity prices as hedged by a solar VPPA.

This is possible because, under the amended standard, it is no longer necessary to demonstrate physical or temporal alignment between consumption and generation. It is sufficient that the company is exposed to the same underlying price risk — for instance, within the same market zone and time band — and that the hedge is structured consistently with that risk.

Another illustrative example of the amendment’s flexibility is the possibility to enter into a VPPA linked to a generating asset located in a different market zone from where the company consumes energy.

Consider a manufacturer with operations and consumption in the Northern Zone of Italy, who enters into a VPPA tied to the zonal price of a solar plant located in Sicily, in order to benefit from higher production efficiency.

Under the previous IFRS 9 framework, the geographical disconnect and lack of correlation between the price risk exposure and the generation location would have likely prevented hedge accounting eligibility, due to insufficient alignment between the hedged item and the hedging instrument.

The amendment changes this: the company should now be able to designate its exposure to energy prices in the Sicily zone as the hedged item — even if consumption occurs elsewhere — provided there is a financial exposure aligned with the contract and that forward price curves are available for the relevant market.

The Hedged Item: More Flexibility, but Also More Responsibility

The core innovation of the amendment lies in a redefinition of the hedged item — allowing companies to construct hedge relationships based on economic risk components, rather than requiring direct matching of physical flows.

What can be designated today

It is now permissible to designate as a hedged item:

• An exposure to the market price of electricity in a specific zone (e.g. Italy — Northern Zone);
• A specific time band (e.g. PEAK hours);
• A forecast volume, determined using simulation models based on meteorological and technical data for the underlying asset.

The logic behind the new approach

The focus shifts from physical transaction matching to economic exposure alignment. A hedge is deemed effective if the VPPA protects the company from adverse price movements within the risk profile it faces.

It no longer matters that production and consumption happen at the same time — only that they share the same underlying market risk.

This paradigm shift removes the burden of modeling precise alignment between consumption and generation curves — but does not eliminate the need for documentation. Instead, it transfers it to the domain of quantitative modeling and methodological validation.

The role of simulation

To qualify for hedge accounting, the hedged volume must be:

• Highly probable, based on sound and supportable assumptions;
• Quantified using a credible production forecast for the plant;
• Expressed in a format aligned with the forward price data used for valuation (e.g. monthly volumes, PEAK time band).

To support this, companies typically rely on:

• PVGIS, Meteonorm, or similar models for solar assets;
• Historical wind and production data for wind-powered facilities;
• Multi-year simulations that yield a representative “average year” production profile to support static designations in hedge documentation.

The resulting monthly profile is held constant across the contract horizon but is considered a reliable proxy for expected output based on climate-normal conditions.

In light of this increased regulatory flexibility, Treasury teams must ensure methodological integrity, documentation traceability, and consistency between hedged items, hedging instruments, and valuation models.

Go to the next page to learn about the expectations from the Treasury Function