FASB s new hedging standard AGA Accounting Principles Committee Meeting

Transcription

1 FASB s new hedging standard AGA Accounting Principles Committee Meeting Glen Hecht, Partner August 14, 2017

2 Contents 1 Overview.. 2 Impact of change and business opportunities. 3 Key implementation considerations. 4 Other Page 2

3 Overview Page 3

4 What s staying the same? All aspects of Accounting Standards Codification topic (ASC) 815 not related to hedge accounting Types of accounting hedges (i.e., cash flow hedges, fair value hedges, net investment hedges) Need to assess hedge effectiveness prospectively and retrospectively Highly effective threshold Requirement to contemporaneously document hedging relationships Page 4

5 What s changing? The Financial Accounting Standards Board (FASB) has proposed targeted amendments to its hedge accounting model to better portray the economics of an entity s risk management activities in its financial reporting Proposed changes address constituent feedback on the existing model, including: Complexity surrounding the application of hedge accounting Restrictions on risks that are eligible to be hedged Users difficulty in understanding hedge results, including hedge ineffectiveness The proposed guidance is expected to be issued in Q and available for early adoption immediately Page 5

6 Snapshot of key proposed changes The standard would impact companies in the following ways: A B C Improve existing hedge strategies New hedge strategy opportunities New presentation and disclosure requirements Current criticism with ASC 815 Complexity surrounding the application of hedge accounting Restrictions on risks that are eligible to be hedged Users difficulty in understanding hedging results FASB s proposed improvements Simplify certain hedge documentation and assessment requirements Allow contractually specified risk components to be hedged Introduce additional disclosures and align presentation and timing of earnings recognition Impact & expected benefits Reducing operational cost and complexity when applying hedge accounting Aligning the financial reporting for derivatives with an entity s risk management objectives by permitting certain hedge strategies that were previously disallowed Eliminating the need to separately measure and present hedge ineffectiveness Provide more useful disclosures Page 6

7 A Improve existing hedge strategies Shortcut method FASB s proposal would retain the shortcut method but attempt to reduce the potential impact associated with its misapplication Critical terms match method When hedging a group of forecasted transactions (e.g., foreign denominated sales occurring over a specified month), the proposal would allow entities to use the critical terms match method, without initial quantitative analysis, if: The hedging instrument s maturity and the forecasted transactions occur within the same 31-day period All other critical terms match Page 7

8 A Improve existing hedge strategies Effectiveness testing Would continue to be required at inception (unless qualified for the critical terms match, shortcut or simplified hedge accounting method) Would allow companies until the end of the quarter to complete the quantitative testing portion of hedge documentation requirements All other documentation requirements will continue to be required, including a description of how the hedge relationship will be assessed Option to perform subsequent tests qualitatively unless facts and circumstances change to an extent cannot qualitatively assert hedge was, and continues to be, highly effective Under the existing model, quantitative effectiveness testing is required at inception and at least quarterly thereafter (unless qualified for the critical terms match, shortcut or simplified hedge accounting method) Page 8

9 New hedging strategy opportunities B Nonfinancial hedging relationships Under the existing model, companies are generally required to hedge the total price risk of nonfinancial items such as commodities. Total price risk typically includes a base price or market index and a basis differential related to the location or grade of the commodity This requirement can result in the recognition of ineffectiveness or, in some cases, the failure to qualify for hedge accounting Derivative Hedged item NYMEX Nat gas NYMEX Nat gas Transportation Grade differential Current US GAAP requires the designation of the total price risk Page 9

10 New hedging strategy opportunities B Nonfinancial hedging relationships Under the proposed guidance companies would be allowed to hedge contractually specified components linked to an index or price stated in the contract (applicable to cash flow hedges only). For example: Company ABC enters into a contract to sell natural gas at Transco Zone 6 for a variable price specified in the contract as NYMEX price + variable spread. The company can identify the NYMEX price as the hedged risk and hedge just that component. Airline XYZ enters into a contract to purchase jet fuel for a variable price specified in the contract of Gulf Coast Platts Jet fuel + variable spread. The airline wants to use a crude oil derivative to hedge its jet fuel purchase. The airline cannot identify the crude oil component in the jet fuel price as it is not contractually specified Derivative NYMEX Nat gas Hedged item NYMEX Nat gas Variable spread Contractually specified component Derivative WTI Crude Oil Hedged item Platts Jet Variable spread Platts Jet not crude oil component To qualify for hedge accounting, XYZ will need to demonstrate that a hedge of Platts Jet (not the crude oil component within it) will be highly effective. Page 10

11 New hedging strategy opportunities B Nonfinancial hedging relationships Additional conditions to hedge nonfinancial components The variable exposure attributable to the contractually specified component must exist throughout the life of the hedging relationship. All stated components of the price must: Relate to the cost of purchasing or selling the asset in the normal course of business and reflect market conditions at contract inception Caps or floors in the contract that limit variability in the specified component need to be considered in assessing hedge effectiveness. A contract is not required throughout the entire hedging period However, the component being hedged must be specified in the contract when executed If the contract specifies a different component, the hedge would not need to be dedesignated if the different component that is specified would still be highly effective Page 11

12 New hedging strategy opportunities B Nonfinancial hedging relationships Additional considerations Understanding what constitutes an agreement. For example: Could an entity designate the contractually specified component of a spot commodity purchase if it receives an invoice or receipt at the time of purchase that specifies how the spot price was determined? Final wording will be important. Entities that purchase commodities using fixed price contracts but hedge the variability of that purchase in advance of signing the contract and fixing the price. The proposed amendments would suggest that an entity could not designate a nonfinancial component in this relationship but would instead be required to designate the total price risk. Page 12

13 New hedging strategy opportunities B Financial hedging relationships Hedging components of financial items Variable-rate hedged items Would allow any contractually specified index rate to be designated as the hedged risk (not just benchmark interest rates) Fixed-rate hedged items Component hedging would still be limited to benchmark interest rates, but SIFMA municipal swap rate would be added to the list of eligible benchmark interest rates Under the existing model, for both variable- and fixed-rate items, only benchmark interest rates specified in ASC 815 may be identified as the hedged risk Page 13

14 New hedging strategy opportunities B Financial hedging relationships Long-haul method for fair value hedges of interest rate risk Proposal would provide entities with flexibility in measuring the change in the fair value of hedged item by allowing: Entities to determine the change in fair value of the hedged item using only the portion of the contractual cash flows related to the benchmark interest rate, not the entire coupon Entities that hedge prepayable instruments to consider only how changes in the benchmark interest rate affect the decision to prepay the instrument, rather than all factors that would affect this decision Entities to calculate the change in fair value of a hedged item in a partial-term hedge of a fixed-rate financial instrument by assuming that its maturity date matches the designated cash flows being hedged Page 14

15 C New presentation and disclosure requirements The proposal will further align the timing of earnings recognition and income statement presentation of the hedging instrument with the hedged item. The proposal eliminates the need to separately measure and report hedge ineffectiveness. Timing of when change in FV of hedging instrument is reported in earnings Cash flow and net investment hedges The entire change in fair value of the hedging derivative included in the assessment of hedge effectiveness would be recorded in accumulated other comprehensive income (AOCI) and reclassified into earnings when the hedged item affects earnings. Fair value hedges no change Excluded components base recognition model is amortization approach Presentation Generally require entities to report the entire effect of the hedging instrument and the hedged item in the same income statement line item. Page 15

16 C New presentation and disclosure requirements Excluded components Certain components of a hedging instrument (i.e., forward points) are allowed to be excluded from the hedging relationship and effectiveness assessment. The FASB decided that the base recognition model for excluded components would be amortization to earnings over the expected life of the hedged item. Entities also would be allowed, as an accounting policy election, to apply a mark-tomarket through earnings approach for excluded components. Cross currency basis spread was added to the list of excluded components. Page 16

17 Impact of change and business opportunities Page 17

18 Benefits of streamlining end-to-end derivative and hedge accounting operations Reducing the time that companies spend on Hedge Accounting (HA) compliance activities will increase their ability to focus on strategic issues Qualitative benefits of streamlining derivative operations are invaluable Value of the activity for the business Today Decision support & analytics Control Reporting HA Compliance activities Potential reduction in end-to-end hedge accounting operating costs In the future Decision support & analytics Control Reporting HA Compliance activities Represents the level of value the activity contributes to the business Improve effectiveness Shift resourcing mix toward higher-value activities (e.g., treasury, purchasing, planning, reporting, etc.) Improve internal control effectiveness Drive focus on service and quality Enable continuous process improvements Improve efficiency Reduce operations cost by: Eliminating redundancies and non-value added activities (ineffectiveness measurement, assessment testing, etc.) Optimizing processes through standardization and leveraging economies of scale and skills (e.g., hedge accounting automation) Reduce process errors Improve organizational flexibility Provide ability to meet demand variance and realign resources Provide ability to quickly integrate acquisitions and divestitures Page 18

19 Summary of impact of proposed changes Current criticism Proposed improvements Impact A Improve existing hedge strategies Complexity surrounding the application of hedge accounting Allow more time for the preparation of initial effectiveness testing Reduce the costs and complexity of monitoring effectiveness testing by allowing more qualitative assessments Relax requirements for critical terms match (CTM) method of assessment Make the shortcut method more forgiving Increase hedge effectiveness by allowing cross currency basis spread as an excluded component M M M L L B New hedge strategy opportunities Restrictions on risks that are eligible to be hedged Permit hedging for contractually specified components of non-financial contracts (i.e., the NYMEX or CME index price) Permit amortization approach for excluded components in fair value and cash flow hedges Permit certain assumptions to make fair value hedging of financial instruments more feasible Permit cash flow hedges of contractually specified rate in variable-rate financial instruments H H L L C New requirements Users difficulty in understanding hedging results Eliminate the need to separately measure, track, and report hedge ineffectiveness Present entire change in fair value of a hedging instrument in the same line item as the hedged item Amend existing and introduce new disclosures to provide more meaningful information H H H Page 19

20 B New hedging strategy opportunities 7 Permit hedging of contractually specified component of non-financial contracts (Cash flow hedges only) Proposed amendments For cash flow hedges of nonfinancial items, an entity would be able to designate the variability in cash flows attributable to changes in a contractually specified component (i.e., NYMEX, CME, LME, etc.) as the hedged risk. Business opportunities Able to hedge nonfinancial risk components that are contractually specified, e.g. a significant benefit for commodity hedging. Elimination of significant ineffectiveness that exists today when hedging total price risk of non-financial contracts. Challenges May require re-negotiation of supplier contracts to contractually specify risk hedged. Grouping commodity contracts into homogenous portfolios that share the same contractually specified risk(s). People, process & technology impact Commodity risk management Hedged item modeling Quantitative testing Data & IT Page 20

21 C New presentation and disclosure requirements 11 Eliminate the need to separately measure, track and report hedge ineffectiveness (Fair value, cash flow, and net investment hedges) Proposed amendments Eliminate the requirement to separately measure and report hedge ineffectiveness. As long as the hedge relationships are highly effective entire change in fair value will go to OCI/CTA for cash flow and net investment hedges, respectively. Business opportunities Eliminate earnings volatility. Increase the benefit of cash flow and net investment hedging strategies. Time does not need to be spent on measuring and tracking ineffectiveness, and for preparing related financial statement disclosures. Challenges May require separate accounting (e.g. OCI amortization for cash flow hedges with non-zero fair value at inception). Change in financial statement processes: No need to separately quantify and explain ineffectiveness in the disclosures/fs. People, process & technology impact I/S presentation changes GL changes Accounting entries Page 21

22 Key implementation considerations Page 22

23 Key considerations for implementation Key considerations for implementation Accounting & reporting Develop and enhance accounting and disclosure processes to reflect requirements of the new hedge accounting model (e.g., no requirement to book ineffectiveness, OCI tracking and release, excluded component amortization and accounting, etc.) Revise hedge accounting policies and change processes (including SOX testing procedures and controls) Develop a process to calculate transition adjustments for both cash flow and fair value hedges Risk management/treasury Conduct a thorough review of existing economic hedging strategies that can be extended to apply hedge accounting under the new guidance Identifying other exposure profiles and forecasted cash flows to identify additional hedging programs that management can apply and that can qualify for hedge accounting under the amended guidance Assessing the operational risk (including SOX, internal control) framework related to transitioning to the new standard Data, systems & IT Develop and retain historical valuation data for disclosures and (modified) retroactive adoption (if applicable) Education/Training Bridge the knowledge gap between current vs. future state requirements across all teams through educational sessions, on the job training, or workshops Page 23

24 Transition Accounting and reporting Effective date Early adoption would be permitted at the beginning of any reporting period from date the amendments are released (expected in Q3 2017) until the effective date. An entity would be required to adopt all of the amendments at one date. Accounting policies All accounting policies and hedge documentation would need to be updated to comply with the amendments upon adoption. One-time election available upon adoption to amend hedge documentation for existing hedging relationships Disclosures New tabular disclosures would be required upon adoption An entity would apply a modified retrospective approach as of the adoption date to hedging relationships existing at that date For cash flow and net investment hedges, the entity would record the cumulative effect of the application of the recognition requirements in AOCI with a corresponding adjustment to the opening balance of retained earnings as of the adoption date Upon adoption, required to provide transition disclosures within ASC 250 on accounting changes and error corrections. Page 24

25 Other Page 25

26 Key aspects of IFRS 9 vs. FASB s Proposed Amendments Issue IFRS 9 Exposure draft Risk components (nonfinancial items) Risk components (financial items) Assessment of hedge effectiveness and threshold Recognition of ineffectiveness for cash flow and net investment hedges Rebalancing Can either be contractually specified or noncontractually specified components (if separately identifiable and measurable) Separately identifiable and measurable Prospective only; no bright-line threshold Recognize through earnings each reporting period Adjustment to hedge ratio to reflect expected changes between hedged item and hedging instrument Voluntary de-designation Not permitted Permitted Only contractually specified components can be identified For cash flow hedges contractually specified; for fair value hedges benchmark interest rates only Both prospective and retrospective; highly effective threshold Record in AOCI (or CTA) and release to earnings when hedged item affects earnings Existing hedge relationship discontinued when hedge ratio is changed Page 26

27 Contact Information Glen Hecht, Partner Financial Accounting Advisory Service Derivatives and financial instruments Page 27

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