FASB staff gave a presentation on an exposure draft (ED) on simplifying hedge accounting under SFAS 133 recently published by the FASB. No decisions were made at this education session.

In an opening remark the staff noted that the objective of the ED is to simplify accounting for and to improve financial reporting of hedging activities. It was also noted that two of the FASB Board members dissented from the issue of the ED, mainly as the ED would not lead to convergence with IFRS and as some of the complex portion hedging would still be allowed. One Board member asked if the FASB considered requiring mandatory fair value measurement for financial instruments. The FASB staff replied that this has been considered but discarded due to time constraints which would have contradicted the idea of having a short-term solution.

The FASB staff then began to present the proposals of the ED. It was emphasised that the eligibility criteria for hedged items would not be changed. Furthermore, the ED would introduce what was called a 'fair value methodology' approach to hedge accounting. The consequences of that approach would be:

• No bifurcation of risk (with exceptions)
• Abolishment of shortcut method and critical terms match
• No quantitative effectiveness test required generally.

The FASB staff then turned to depict the major changes that would be introduced by the ED.

Hedge effectiveness

The FASB explained the new principles that would be established under the ED regarding the hedge effectiveness requirement. It was noted that the quantitative test that 'proves' the effectiveness of a hedging relationship would no longer be required if a qualitative analysis showed a 'reasonable' economic offset between hedging instrument and hedged item. If this is not obvious, however, a quantitative test would still be required. One Board member told the staff that some constituents would have the impression that not requiring an effectiveness test would result in not recognising any ineffectiveness at all. The FASB staff explained that although there would be no effectiveness test required, an entity would still have to measure any ineffectiveness.

Another Board member asked what was meant by the term 'reasonable'. The FASB staff answered that there is no quantitative threshold for this. It was also questioned whether an effectiveness assumption would still be required given that all ineffectiveness would be recognised in profit or loss anyway. The FASB staff responded that the FASB considered this, but that not requiring some notion of effectiveness would essentially result in a fair value option for non-financial items by way of designation. It was also noted that if circumstances suggest that the assumption of effectiveness no longer holds true, effectiveness would have to be reassessed.

Dedesignation

The FASB staff then presented the new dedesignation criteria. It was highlighted that voluntary dedesignation would no longer be permitted under the ED's approach. Instead a hedging relationship would be discontinued if the hedging instrument terminated, sold or expired or would no longer meet the criteria in SFAS 133.21 and .22. Also entering into a derivative contract offsetting the hedging derivative would be consideration effective termination. One Board member asked if this would also trigger recycling of the amount deferred in equity in a cash flow hedge of a forecasted transaction. The FASB staff explained that provided the forecasted transaction is still considered to be highly probable the amount would continue to be deferred until the hedged item affects profit or loss.

Hedged risk

The FASB staff then turned to the definition of hedged risk under the ED. It was noted that the general approach would be that only all risks can be designated with two exceptions:

• Foreign exchange risk
• Interest rate risk in hedge of an entity's own debt if designated at inception.

This would reduce the situations where bifurcation of risk would be possible. It was noted that the designation of a proportion would still be possible.

One Board member asked why these two exceptions were made. The FASB explained that changing the hedge accounting requirements for foreign exchange risk under SFAS 133 that had been carried over from SFAS 52 would have required redeliberating and amending SFAS 52. Regarding the second exception it was argued that this has been done for convenience reasons as entities have indicated they prefer issuing fixed rate debt and then swapping it into variable rate debt, in which case they would have to apply hedge accounting in the absence of invoking the fair value option for the debt instrument. That would have resulted in those entities being required to present changes in their own credit risk inherent in their issued debt. Another Board member asked why this choice would not be permitted for assets. The FASB staff responded that the FASB considered it useful information if users of financial statements would not only see what an entity has hedged, but also what it has not hedged. This would be implemented with the ED's hedge accounting model.

One Board member asked about the interaction of the 'all risks' approach and measuring ineffectiveness and, if necessary, any quantitative effectiveness testing. The FASB staff highlighted that if all risks are designated then all changes in value of the hedged item caused by these risk would be reflected in measuring ineffectiveness (or when testing effectiveness). This is, however, different in a scenario where the ED would still allow designating risk components.

Measurement of hedged items in a fair value hedge

The FASB staff noted that the ED would still require the hedged item to be adjusted for fair value changes. It was also noted that hedged item and hedging instrument must be measured separately and that all contractual cash flows must be included.

Measuring and reporting ineffectiveness in a cash flow hedge

The FASB then continued to present the accounting changes for cash flow hedges. It was noted that the ED would implement the hypothetical derivative method (which compared the actual hedging instrument with a hypothetical derivate that would perfectly offset the risks from the hedged item) and any difference in the value between this derivative and the actual hedging instrument would be reported in profit or loss as ineffectiveness. The FASB staff also highlighted that the approach set out in Implementation Guidance G20 which allows deferring changes in the time value of an option in a cash flow hedge would still be allowed under the ED, but would be moved to the main body of SFAS 133. It was also noted that the time value must be amortised using a 'rational basis'.

Disclosures

The FASB staff then explained the new disclosure requirements under the ED. It was noted that a reconciliation would be required that showed reported amount in the balance sheet, any hedge adjustment and other fair value changes. Furthermore, if an entity hedges the interest rate risk in issued debt, it would be required to disclose the impact of any derivatives on maturity and interest rate of the debt.

Partial-term hedging

At the end of the session, the FASB staff was asked if partial term-hedging would still be possible. FASB staff response was no.

The Chairman thanked the FASB staff for the presentation and closed the session.