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FASB Decision-Making Meeting Recap: June 29, 2015

FASB

The FASB met on June 29th in a decision-making meeting. There were three hedge accounting packages presented for board approval:

  1. Decision package one relates mainly to non-financial hedges and includes component hedging amongst many other exciting changes.
  2. Decision package two relates to financial instrument hedging issues and includes definitions of benchmark rates, callable debt and partial term fair value hedging.
  3. Decision package three relates to shortcut hedge accounting.

Decision Package One

The board voted for Alternative IIA, which includes the following:

Component Hedging

  • Contractually specified components allowed as the hedged item (this will open up commodity hedge accounting to more closely align with risk management practices)
  • Negative basis on a contractually specified component allowed IF it is probable that an entity has full exposure to variability in the price of the component, otherwise must hedge the full price exposure

Effectiveness Measurement

  • Quantitative testing after inception only required if facts and circumstances change
  • Inception quantitative test timing changes – must perform the test by quarter-end. This will allow entities to test based off of the official derivative confirmations and there will be no more 2 business day rule applied to the testing
  • Effectiveness criteria will remain at highly effective

Ineffectiveness

  • Ineffectiveness is eliminated (noise will continue to hit the P&L, but the timing will change)
  • All changes in cash flow hedges will be recorded in OCI until the hedged item impacts earnings
  • OCI must be reclassified to the line item hedged
  • All changes in a fair value hedge must be recorded in the line item hedged

Disclosures

  • Enhanced qualitative disclosures to describe quantitative goals of hedge objectives (this was widely debated and the members asked the staff to include questions surrounding this requirement in the draft)
  • Additional disclosures required about the cumulative-basis adjustment for fair value hedges.
  • Revised disclosure table required to show the impact of hedging on individual income statement line items

Other

  • Voluntary dedesignation remains an option

The board was clear that component hedging must contain safeguards around the criteria for a component to be separated out for hedging. The staff will include safeguards in the proposal.

Decision Package Two

The board voted for Package #2 (of four presented under this Decision Package), which allows the contractually specified variable index rate to be the designated interest rate risk. This package opens up benchmark hedge accounting under cash flow hedging to other indexes besides those defined in ASC 815. In addition, when hedging callable debt under either cash flow or fair value hedging, an entity will be allowed to consider the effect of a prepayment option ONLY as a relates to the risk designated.

The following changes to hedges designated under fair value hedge accounting will be included in the exposure draft:

  • SIFMA added as a benchmark. This gives relief to certain tax-exempt hedgers.
  • The benchmark component of the total coupon will be allowed. This change should eliminate what has been referred to as the total coupon issue, which is currently required under ASC 815 and will allow users to exclude the impact of credit from fair value hedges.
  • Partial term fair value hedges allowed.

Decision Package Three

The board voted for Package C, which has one modification to current guidance which changes what happens when shortcut is disallowed.

If an entity documents, at inception, what the long-haul effectiveness test would be if shortcut hedge accounting is no longer applicable, then they don’t have to perform the test; however if shortcut is subsequently disallowed, they can move to long-haul hedge accounting.

Moving to long-haul hedge accounting would require the entity to subsequently perform the documented effectiveness test as of inception to ensure that the hedge was expected to be highly effective. In addition, the entity would need to compare the results of shortcut versus long-haul and assess if the results are materially different for all reporting periods.

This guidance change is designed to address financial statement users concerns that when shortcut hedge accounting is subsequently disallowed (many times for minor “foot faults”), entities are required to restate their financials as if they had not hedged.

With the new guidance in place, if an entity or one of its regulators subsequently decides that shortcut hedge accounting was not appropriate because of a minor difference in terms, long-haul hedge accounting would be allowed retrospectively (assuming the hedge was highly effective). In addition, if at some time in the future the hedged item changes such that shortcut is no longer appropriate, an entity could move right into long-haul hedge accounting without going through a dedesignation.

Next Steps

The staff will develop a draft, identify any sweep issues, perform a cost benefits and complexity analysis and research transition approaches. The staff expects to have the draft ready in Q4 and the board anticipates issuing an exposure draft by the end of 2015.

Before breaking for the next topic, which was not hedge accounting related, the staff was commended for providing an effective and efficient process to review and vote on the proposed changes. Several board members suggested that the process followed should be applied to other large projects.