FASB proposes changes to hedge accounting standard

The Financial Accounting Standards Board released a proposed accounting standards update Wednesday to better line up a company’s hedge accounting with its risk management strategies.

The proposals build on the hedging standard that FASB issued in 2017, which aimed to better align the economic results of risk management activities with hedge accounting. The new standard increases transparency around how the results of hedging activities are presented, both on the face of the financial statements and in the footnotes, for investors and analysts when hedge accounting is applied.

FASB has been making targeted improvements in its accounting standards since last year, instead of introducing new standards while accountants try to digest the major changes in recent years from new rules for revenue recognition, leases, long-duration insurance, credit losses, measurement and classification of financial instruments, and hedge accounting.

“Broadly speaking, to change accounting standards, I think we first need to make a clear case for change,” said FASB chair Richard Jones during Baruch College’s annual financial reporting conference Wednesday. “As I see it, in my own words, there are three reasons for change. First and foremost is to provide users with better and more useful information that will directly influence their decisions about capital allocations. Second, to remove unnecessary cost and complexity from the system. Then third, to maintain and improve that 11,000-page codification. But before we can successful make a change, we need to clearly communicate the reason for that change. We must also understand who would benefit from that change and how those users would put that information to work.”

FASB chair Richard Jones (bottom) discusses accounting with Baruch College professor Norman Strauss (top left) and SEC acting chief accountant Paul Munter (top right) at Baruch College’s annual financial reporting conference.

One of the main provisions of the 2017 hedging standard was the addition of a “last-of-layer” hedging method. For a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities, the last-of-layer method enables a company to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that’s not anticipated to be affected by prepayments, defaults and other events impacting the timing and amount of cash flows.

Since FASB released the hedging standard in 2017, constituents have told the board that the ability to elect hedge accounting for a single layer is useful, but hedge accounting could better reflect risk management activities if it’s expanded to permit multiple layers of a single closed portfolio to be hedged under the method.

The proposed standards update would expand the current single-layer model to permit multiple-layer hedges of a single closed portfolio of prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments under the method. To reflect that expansion, the last-of-layer method would therefore be renamed as the “portfolio layer method.”

On top of that, the proposed update would clarify eligible hedging instruments in a single-layer strategy. It would also offer more guidance on the accounting for and disclosure of fair value hedge basis adjustments that would apply to both the current single-layer model and the proposed multiple-layer model. In addition, the standards update would indicate how fair value hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio.

The proposed update would apply to all entities that elect to apply the portfolio layer method (currently referred to as the last-of-layer method) of hedge accounting.

The proposed ASU is available at www.fasb.org. FASB is asking its stakeholders to review the document and provide comments by July 5.

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