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FASB Non-Decision Meeting Recap: June 10, 2015 – Part II

FASB

Most of the FASB’s June 10 non-decision making meeting was spent discussing benchmark interest rates.

When FAS 133 was originally written, users had to include the full market interest rate, inclusive of credit. FAS 138 was subsequently approved, allowing the bifurcation of benchmark interest rate risk, which was defined as U.S. Treasuries and – for practical reasons – LIBOR swap rates. A benchmark rate must be widely recognized and quoted in an active market, attributable to high-quality obligors and commonly referenced in transactions. There are currently three approved rates: U.S. Treasury, LIBOR and OIS.

There is broad support among stakeholders to open up benchmark hedging to include more common indexes such as Prime and SIFMA (tax-free municipal swap index); under current rules, these rates don’t qualify for hedge accounting or they introduce ineffectiveness from the credit component. The staff has three considerations for benchmark rates: it’s a proxy for the risk-free rate; it’s a market driven index; it’s a rate that is important to the entity.

Three alternatives were presented:

  • No changes to current GAAP (benchmark hedge accounting continues as-is);
  • Adopt market based definition of all hedges of interest rate risk (without requiring high credit quality)
  • Allow any contractual rate to be the hedged risk for cash flow hedges while fair value hedges would be governed by alternative A, B or other (including IFRS, which defines hedgeable risk as a separately identifiable reliably measurable component).

The staff proposed two questions:

  • Should GAAP allow benchmark hedging of any contractually specified variable rate index? If yes, then the rate would not need to meet any other criteria, and the constituents’ desire to hedge the prime rate using cash flow hedge accounting would be met. Fair value hedging would likely continue to follow current guidance.
  • How should benchmark rates be determined assuming high credit quality is required? (A) retain current GAAP, or (A’) move to principles based approach of identifying characteristics that must be met and include implementation guidance. Discussion centered on the differences between A and A’ and how comfortable the board is with a principles-based approach on a yes/no type of question, different credit qualities and emerging rates. This portion of the meeting closed with a discussion and definition of Prime and SIFMA, the two rates that constituents have currently identified as the most useful to include for hedging purposes.

Click here to watch a webcast of the meeting or learn more about part I.