Hedge Accounting Guidance Changes: Making Sense of FASB s Proposal. Helen Kane

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2 Hedge Accounting Guidance Changes: Making Sense of FASB s Proposal Helen Kane hkane@hedgetrackers.com

3 Hedge Trackers, LLC

4 Agenda FASB s Proposed Changes to Hedge Accounting o Hedge-able risk o Documentation o Effectiveness Testing o Effectiveness Measurement o Accounting o Disclosures Next Steps & Activity Timeline

5 Hedge-able Risk

6 Hedge-able Risks More risks may be bifurcated, some sources of ineffectiveness not part of hedged item OLD FV hedging included all contractual cash flows Bifurcated CF risk limited to benchmark Interest Rates Hedged risk must impact Parent s earnings NEW Specific identification of hedged item: like items testing Overall, FX, interest rate, credit risk hedge-able FX derivative held by entity with exposure or one with same functional currency No Net Hedging Expands hedged risk to contractual component of physical purchase/sale contracts Expands hedge-able indexes to any contractual index for variable rate underlying Components of fixed rate debt instruments (partial term hedge, benchmark component of coupon) Expanded FV benchmarks to include SIFMA Last Layer hedged item in Fair Value interest rate exposure

7 Effectiveness Testing (now Assessment)

8 Effectiveness Assessment Frequency and timing requirements have been relaxed NEW Initial effectiveness assessment performed by quarter end Back-up test for assumptions of perfect effectiveness Matched term on anticipated transaction = within 31 day period Cross currency basis can be excluded Highly effective requirement Time value may be excluded from effectiveness assessment OLD Effectiveness assessment required at inception (PCC exception) Matched terms/ Short-cut acceptable Ongoing Prospective and Retrospective effectiveness assessment required at least quarterly Initial effectiveness assessment required contemporaneously with hedge designation

9 Effectiveness Measurement

10 Effectiveness Measurement NEW 100% of tested component is effective OLD Calculate effective and ineffective elements of derivative

11 Accounting

12 Derivative Accounting Reduced flexibility on P&L geography of derivative gains/losses OLD NEW All derivative gains/losses reclass to same line item as hedged item for CF &FV hedges Excluded TV may be amortized or M2M through P&L (policy election) Elect where excluded time value will be recorded for Net Investment Hedges (only) OCI reclass to P&L timing mirrors hedged item Elect where effective, ineffective, and excluded derivative gains/losses will be recorded for Cash Flow and Fair Value Hedges Record ineffectiveness in P&L

13 Documentation

14 Documentation Reduced requirements reflect other changes in guidance NEW Contemporaneous documentation Special Accounting Designation Nature of hedged risk Strategy & Objective Counterparty & Trade details OLD Sufficiently specific details of hedged item Election to include/exclude time value Description of prospective test/models Trigger rules CF: OCI Release rules FV: how FV hedged item change will be recorded in income Contemporaneous reporting of inception effectiveness results Retrospective test description Where gains/losses will be recorded

15 Disclosures

16 Disclosures NEW Consolidating derivative gain/loss reporting by P&L geography across asset classes/hedge type Quantitative goals OLD Reporting derivative gain/loss impact on balance sheet, income statement and cash flows. How/why company uses derivatives How derivatives accounted for (CF, FV, NI, not designated) OCI rollforward, Events that will move OCI to P&L Expected OCI to P&L in next 12 months P&L impact of failed hedge relationships Collateral & credit risk concentration Volume of trading Cross references Basis adjustment for FV hedged items

17 The Effect of Derivative Instruments on the Statement of Financial Performance for the Years Ended December 31, 2010, and 2009 Location of Gain or (Loss) on Derivative Instruments and Related Hedged Items (a) Interest Contracts Fair Value Hedging Relationships in Subtopic Hedged Items Gain or (Loss) on Commodity Contracts Commodity Contracts Recognized in Income (Amount Excluded from Effectiveness Testing) Hedged Items Cash Flow Hedging Relationships in Subtopic Interest Contracts Gain or (Loss) on Commodity Contracts Commodity Contracts Recognized in Income (Amount Excluded from Effectiveness Testing) Total Amounts of Income and Expense Line Items Presented in the Statement of Financial Performance (b) 2010 In the statement of financial performance (c) Cost of goods sold $XX,XXX $XX,XXX $XX,XXX $XX,XXX $XX,XXX $XX,XXX $XX,XXX Interest expense XX,XXX XX,XXX XX,XXX n/a XX,XXX XX,XXX XX,XXX $XX,XXX n/a $XX,XXX XX,XXX Amount of gain or (loss) recognized in accumulated other comprehensive income n/a n/a n/a n/a n/a XX,XXX XX,XXX n/a n/a Amount of gain or (loss) reclassified from accumulated other comprehensive income into income n/a n/a n/a n/a n/a XX,XXX XX,XXX n/a n/a 2009 In the statement of financial performance (c) Cost of goods sold XX,XXX XX,XXX XX,XXX XX,XXX XX,XXX XX,XXX XX,XXX Interest expense XX,XXX XX,XXX XX,XXX n/a XX,XXX XX,XXX XX,XXX Amount of gain or (loss) recognized in accumulated other comprehensive income n/a n/a n/a n/a n/a XX,XXX XX,XXX Amount of gain or (loss) reclassified from accumulated other comprehensive income into income n/a n/a n/a n/a n/a XX,XXX XX,XXX XX,XXX n/a n/a n/a XX,XXX XX,XXX n/a n/a

18 Private Company

19 Derivative Accounting Additional Relief for Private Companies that are not Financial Institutions All additional documentation and assessments timing: when next set of financials issued NEW At inception document intent: specifically hedge instrument, hedged item (specific), and nature of risk Accounting Disclosures OLD Meet all hedge documentation and effectiveness testing requirements and timing

20 Overview

21 Proposed Guidance Increased access to hedge accounting, simplified debits & credits, less testing, revised disclosures NEW Hedge-able risks to include contractual risk Effectiveness testing timing delayed to quarter end Derivative gain/loss geography must follow hedged item in P&L Highly Effective Documentation requirements Prospective Testing Cash Flow accounting to OCI, Fair Value accounting to hedged item No measurement or Disclosure impact on accounting for ineffectiveness P&L, Balance Sheet, Disclosure by P&L line liquidity. item across asset classes and designation Disclosure of quantitative objectives OLD Retrospective Testing Ongoing Prospective Testing Measurement and accounting for ineffective components

22 Next Steps

23 Staff Plan: Q ASU Release Finalize concepts Circulated fatal flaw draft (limited) Finalize and transition time frames

24 Transition Plan Early adoption would be permitted at start of any fiscal year before effective date Modified retrospective approach o cumulative effect of application would be recorded as an adjustment to retained earnings as of the beginning of the most recent fiscal year presented on the date of adoption. Transition disclosures

25 Elections To amend documentation on existing relationships o to move to qualitative assessment o to add back-up test to short-cut Amend hedge of overall risk to contractually specified risk with zero fair value of hypothetical derivatives at original designation date NO transition offered on FV partial term hedges

26 Modified Retrospective For Cash Flow & Net Investment Hedges o Cumulative effect of opening balance adjustment to OCI offset in retained earnings.

27 Evaluate Impact to Your Program

28 Impact to Existing Hedge Programs More hedge-able fair value exposures No ineffectiveness measured or reported Gains/loss P&L geography dictated o May differ from current election Less risk for short-cut/matched terms assumptions o Less testing for long-haul More disclosures Fewer restatements!!!

29 FASB Perspective The mission of the FASB is to establish and improve standards of financial accounting and reporting that provides decisionuseful information to investors and other users of financial reports. FASB has a concern for investors, other users, and the public interest in matters of financial accounting and reporting Understand you are not the target audience

30 Corporate Process Discovery o Get original documents: ASU16-XX from FDocument_C%2FDocumentPage&cid= &project_id= o Additional Insights Sources o Audit Firm, Banks, Peers, Industry Leaders Medium Articles, Webinars

31 Internal Discussions Timing: earliest implementation is start of fiscal year following issuance Prepare list of all changes to impact your company now (and in future) o Survey accounting personnel to identify relevant changes and your position o Survey treasury personnel to identify relevant changes and your position Reconcile competing interests

32 Questions?

33 CONNECT WITH US CONNECT WITH linkedin.com/company/hedge-trackers hedgetrackers.com/newsletter hedgetrackers.com/blog Helen Kane President linkedin.com/in/hthelenkane