In my Risky Business blog of February 4, 2010, I wrote about the IASB’s continued intent to converge with the FASB by June 2011, under the MOU outlined by the G20 in September 2009. It was anticipated that the IASB was on track to come out with an Exposure Draft (ED) on changing hedge accounting under IAS 39 ahead of the FASB, which had a failed attempt at changing FAS 133 a few years prior. Instead, the FASB came out with an ED on Financial Instruments this summer, and it just closed its comment period receiving over 3,000 comment letters (apparently over five times the record on any ED). Although most of the letters were reactions to fair value approaches, there were several concerns expressed to potential changes to FAS 133.
With the last meeting on hedge accounting completed by the IASB, it is widely expected that at long last Phase III of IFRS 9 ED will be released in the coming weeks. From what we are hearing, there are several dramatic divergences from what the FASB has proposed for changes to FAS 133. Here are some of the expected key differences under the IASB’s pending ED:
- Fair value hedges will go to OCI with ineffective component going to P&L, big divergence from FASB where fair value goes to P&L.
- No bands, no “reasonably” effective assessment. In other words you could be 1% effective and have 99% go to P&L without fear of being disqualified on that basis. This is a big divergence from the FASB’s potential change of using “reasonably” instead of “highly” and already the band is being labeled by the market as 50%/150%.Since there are no bands, the hedge cannot deliberately be entered into as a mismatch, i.e., you cannot use a CAD interest rate swap to hedge a USD interest rate swap.
- Effectiveness testing approaches are not prescribed. If ineffectiveness does increase throughout the life of the hedge, then expected that you would have to perform quantitative tests to prove you had not deliberately entered into a hedge mismatch.
- Commodity hedging will be easier! At last, companies can hedge the non-financial component, i.e., the copper in the copper pot, as long as it can be identifiable and measureable.
- Can’t de-designate voluntarily, which is convergent with the new FASB ED.
- Derivatives can be hedged items, so you can swap a swap, e.g., to hedge a Gold swap as a GBP Functional CCY company, you can first hedge the Gold floating price risk, then add a GBP/USD forward strip on top.
- Time value of options will be amortized rationally over life, so still no FASB DIG G20 Hypothetical method, but a convergence with the FASB’s proposed changes
- Bifurcation of embedded derivatives continue, which is different from the FASB’s ED, which would have entities valuing the entire contract.
- Fair value of liabilities will have the credit value adjustment flow into OCI instead of P&L.
The IASB does make some good progress to promote more economic hedging, but it is very different from the FASB approaches all along. So will the FASB re-issue again a new ED to better line up with IFRS 9 or will companies with reporting entities under different regimes have to report under two completely different standards and systems? So much for the MOU.