Will FAS 133 (ASC 815-20) Revised be the New Frontier for Derivative Accounting?

The FASB is expected to issue an exposure draft to FAS 133 (ASC 815-20) as part of the Financial Instruments Project in the next few days.  Assuming for once,  that the FASB keeps to its timetable (don’t hold your breath, I’m not),  the Exposure Draft is basically expected to be a re-issue of the Exposure Draft that was issued in July 2008, and one that generated approximately 127 comment letters.   Here’s a quick recap of the highlights of the old exposure draft:

  1. Elimination of bifurcation of risk (foreign exchange risk and interest rate risk of issuance day hedges of own debt, exempt)
  2. Elimination of Short-cut and Critical Terms Match
  3. Elimination of intercompany hedge accounting, unless stringent criteria were met
  4. Making the FAS 133 paragraph 30(b) rule, symmetrical (related to cash flow hedges)
  5. Changing assessment criteria from highly effective to “reasonably effective”

The new exposure draft is expected to be a re-issuance of the old exposure draft with one big change: The FASB is now expected to allow bifurcation by risk.  This is probably because the majority of the comment letters posted to the FASB took exception to this elimination the first time around.  It is tough to have Generally Accepted Accounting Principles (GAAP) if most of the Fortune 500 companies don’t accept a particular principle!

I think the new Exposure Draft is a step in the right direction; however, I feel it is about eight or nine years too late.  At this point, most sophisticated hedgers have made significant investments in systems and processes to do rigorous quantitative assessments and those processes seem to have lowered “audit risk” considerably in comparison to the “go-go” years of the early 2000’s. Most companies I’ve spoken with expect to keep these processes in place as it is good risk management.   Moreover, the industry has come to accept “highly effective” to mean 80-125%, but it’s anyone’s guess what “reasonably effective” will be.  I’ve heard ranges from (70-130% to 50-150%).  Also, the joint FASB/IASB board should be putting out their own recommendation soon, and I think the longer view on convergence to IFRS might require companies to adopt amendments to FAS 133 now and then require more changes to IFRS later on.

Not much more to write on this subject until the Exposure Draft actually comes out, so stay tuned…