IASB urged to take its time as hedge talks falter

Hedge accounting, the third and final piece of the controversial fair value standard, has stumbled at its first hurdle.

A joint meeting of US and International standard setters failed to decide on the objective of hedge accounting when they met in early February.

The standard is the third part of the International Accounting Standards Board’s review of its fair-value standard known as IAS 39.

The board’s review of hedge accounting is occurring in tandem with attempts to harmonise its accounting rules with those in the US.

Vincent Papa, director with the Chartered Financial Analyst Institute, would prefer the IASB take its time, and undertake a thourough revision of the standard. “Those (original) deadlines were not realistic,” he said. “If they are doing it in essence with a gun to their head, due to the political environment, a crisis-orientated environment, for users, that would not be a preferable outcome.”

Hedge accounting enables companies to smooth out financial volatility. Changes in currency or markets, amid a range of factors, may create uncertainty around an item’s expected cash flows or value. Companies can enter into separate contracts to counter and offset this risk – effectively hedging their bets.

Hedge accounting allows companies to link two, ordinarily separate, contracts in their financial statements, and reflect this in profits. The objective is to provide investors with a better picture of a company’s position and financial performance.

Hedge accounting is, however, sometimes criticised as being restrictive. Under current rules companies must document the objective and strategy at the inception of a hedge. They must also judge the effectiveness of the hedge.

The issue brought American bank Fannie Mae unstuck in 2006 when then US Securities and Exchanges Commission chairman Christopher Cox said the bank “sought to fit the vast majority of its transactions into a simplified method of applying hedge accounting”.
Under current rules, if a hedge is not “highly effective”, the transactions are treated independently and fed through the profit and loss statement.

Many companies do not bother with hedge accounting, either unwilling or unable to comply with the conditions, but the IASB wants to change this. The board is attempting to whittle down the rules to a collection of principles.

Proposals were expected by December 2009, but were delayed to March 2010. Now this date is being seen as optimistic. The IASB say they are committed to a root and branch revision of the standard.

FANNIE HEDGES ITS BETS

In June 2006 US mortgage lender Fannie Mae reported an $11bn (£7bn) reduction of previously reported net income due in no small part to its failure to appropriate comply with hedge accounting rules.

In the US hedge accounting was governed under rule FAS 133, which formed the basis of the International standard now being revised.

Then U.S. Securities & Exchange Commission chairman Christopher Cox said Fannie Mae tried to fit a majority of its transactions into its own hedge accounting system.

Cox said Fannie did not have adequate systems or personnel in place to comply with FAS 133's provisions, “in particular, with provisions that require periodic assessment of effectiveness and measurement of ineffectiveness”.

Fannie Mae agreed to pay $400m at the time.

Further reading:

IASB Phase III - Hedge accounting