Board Meeting Handout Accounting for Financial Instruments: Hedging March 8, 2017

Transcription

1 Board Meeting Handout Accounting for Financial Instruments: Hedging March 8, 2017 PURPOSE OF THIS MEETING 1. The purpose of this decision-making Board meeting is to discuss the following issues for redeliberation: (a) (b) Issue 1: Should the market yield test in the proposed Update be retained or eliminated? Issue 2: Should the last of layer approach be incorporated into the current hedge accounting project for fair value hedges of interest rate risk of prepayable instruments? ISSUE 1: THE MARKET YIELD TEST Overview 2. In the proposed Update, the Board decided that it would allow an entity to use benchmark rate coupon cash flows determined at hedge inception in calculating the change in fair value of the hedged item attributable to interest rate risk except in one circumstance. When the current market yield of the hedged item is less than the benchmark interest rate at hedge inception (referred to as a sub-benchmark hedge), total contractual coupon cash flows of the entire hedged item must be used in measuring the change in fair value of the hedged item attributable to interest rate risk. This is referred to as the market yield test. Alternatives 3. There are two alternatives for consideration: (a) (b) Alternative A: Retain the proposed test ( component view ). Alternative B: No test ( conversion view ). The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 7

2 4. The question for the Board is as follows: Question 1 for the Board 1) Does the Board believe the market yield test to determine whether benchmark cash flows may be used to measure the change in fair value of the hedged item attributable to interest rate risk should be retained or alternatively does the Board believe that no test should be required? ISSUE 2: FAIR VALUE HEDGES OF INTEREST RATE RISK OF PREPAYABLE INSTRUMENTS 5. At the January 25, 2017 Board meeting, the Board agreed that the staff should research the accounting issues associated with fair value hedges of interest rate risk for prepayable financial assets to determine if a targeted and simplified approach to address these issues could be developed in this project. 6. The question for the Board is as follows: Question 2 for the Board 2) Does the Board want to incorporate the last of layer approach into the current hedge accounting project? 7. The following pages contain draft guidance to the Codification regarding the last of layer approach: Page 2 of 7

3 DRAFT The following guidance represents the FASB staff's drafting of the Board s potential decision on the last of layer approach for fair value hedges of interest rate risk for prepayable financial assets. For readability and context, the staff has provided guidance currently in Topic 815 and guidance previously issued in the proposed Update. Marked language only reflects draft guidance for the last of layer approach. Final wording is subject to change for the final Update Hedges involving a benchmark interest rate are addressed in paragraph (f) (for fair value hedges) and paragraph (j) (for cash flow hedges). Hedges involving a contractually specified interest rate are addressed in paragraph (j) (for cash flow hedges). The benchmark interest rate or the contractually specified interest rate being hedged in a hedge of interest rate risk shall be specifically identified as part of the designation and documentation at the inception of the hedging relationship. Paragraphs A through 25-19B provide guidance on the interest rate risk designation of hedges of forecasted issuances or purchases of debt. An entity shall not simply designate prepayment risk as the risk being hedged for a financial asset. However, it can designate the option component of a prepayable instrument as the hedged item in a fair value hedge of the entity s exposure to changes in the overall fair value of that prepayment option, perhaps thereby achieving the objective of its desire to hedge prepayment risk. The effect of an embedded derivative of the same risk class shall be considered in designating a hedge of an individual risk. For example, the effect of an embedded prepayment option shall be considered in designating a hedge of interest rate risk (unless the hedged item is designated pursuant to paragraph (b)(2)(v)) An asset or a liability is eligible for designation as a hedged item in a fair value hedge if all of the following additional criteria are met: a. The hedged item is specifically identified as either all or a specific portion of a recognized asset or liability or of an unrecognized firm commitment. b. The hedged item is a single asset or liability (or a specific portion thereof) or is a portfolio of similar assets or a portfolio of similar liabilities (or a specific portion thereof), in which circumstance: 1. If similar assets or similar liabilities are aggregated and hedged as a portfolio, the individual assets or individual liabilities shall share the risk exposure for which they are designated as being hedged. The change in The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 3 of 7

4 DRAFT fair value attributable to the hedged risk for each individual item in a hedged portfolio shall be expected to respond in a generally proportionate manner to the overall change in fair value of the aggregate portfolio attributable to the hedged risk. See the discussion beginning in paragraph for related implementation guidance. An entity may use different stratification criteria for the purposes of Topic 860 impairment testing and for the purposes of grouping similar assets to be designated as a hedged portfolio in a fair value hedge. 2. If the hedged item is a specific portion of an asset or liability (or of a portfolio of similar assets or a portfolio of similar liabilities), the hedged item is one of the following: i. A percentage of the entire asset or liability (or of the entire portfolio). An entity shall not express the hedged item as multiple percentages of a recognized asset or liability and then retroactively determine the hedged item based on an independent matrix of those multiple percentages and the actual scenario that occurred during the period for which hedge effectiveness is being assessed. ii. One or more selected contractual cash flows, including one or more individual interest payments during a selected portion of the term of a debt instrument (such as the portion of the asset or liability representing the present value of the interest payments in any consecutive two years of a four-year debt instrument). Paragraph B discusses the measurement of the hedged item in hedges of interest rate risk iii. A put option or call option (including an interest rate cap or price cap or an interest rate floor or price floor) embedded in an existing asset or liability that is not an embedded derivative accounted for separately pursuant to paragraph iv. The residual value in a lessor s net investment in a direct financing or sales-type lease. v. The last dollar amount, if the hedged item is a closed portfolio of prepayable assets or a beneficial interest in a portfolio of prepayable financial instruments. 01. An analysis must be completed that supports the last dollar amount will be outstanding at the stated maturity of the hedging relationship based upon current expectations of the portfolio or collateral performance. 02. An entity may assume that if prepayments occur, they are first applicable to the portion of the portfolio of prepayable assets or beneficial interest that is not part of the last dollar amount designated as the hedged item Page 4 of 7

5 DRAFT > > > > Determining Whether Risk Exposure Is Shared within a Portfolio This implementation guidance discusses the application of the guidance in paragraph (b)(1) that the individual assets or individual liabilities within a portfolio hedged in a fair value hedge shall share the risk exposure for which they are designated as being hedged. If the change in fair value of a hedged portfolio attributable to the hedged risk was 10 percent during a reporting period, the change in the fair values attributable to the hedged risk for each item constituting the portfolio should be expected to be within a fairly narrow range, such as 9 percent to 11 percent. In contrast, an expectation that the change in fair value attributable to the hedged risk for individual items in the portfolio would range from 7 percent to 13 percent would be inconsistent with the requirement in that paragraph A If the hedged item is designated pursuant to paragraph (b)(2)(v) and incorporates the measurement mechanics discussed below, the quantitative test discussed in paragraph would not need to be performed as each asset in the portfolio would be identical from a hedge accounting perspective: a. The entity documents that it is mitigating fluctuations in the interest rate risk for only a portion of the remaining term of the portfolio, pursuant to paragraph , such that the expected maturity date of each hedged item is identical from a hedge accounting perspective; and b. The entity measures changes in fair value of the hedged item based upon the benchmark component of the contractual coupon, pursuant to paragraph A. The combination of using the benchmark component of the contractual coupon when (i) all assets have the same assumed maturity and (ii) prepayment risk does not impact the hedged risk, will result in all hedged items having the same benchmark component coupon. i. A fair value hedge of interest rate risk typically cannot exclude prepayment risk. However, if the hedged item is designated pursuant to paragraph (b)(2)(v), prepayment risk will not impact the hedged risk. As long as the amount of the asset or portfolio expected to be outstanding in the portfolio at the end of the hedging relationship is greater than the amount of UPB designated as the last layer, the hedged item and hedged risk will not be impacted by prepayment risk. Page 5 of 7

6 DRAFT In aggregating loans in a portfolio to be hedged, an entity may choose to consider some of the following characteristics, as appropriate: a. Loan type b. Loan size c. Nature and location of collateral d. Interest rate type (fixed or variable) e. Coupon interest rate (if fixed) f. Scheduled maturity or the assumed maturity if the hedged item is measured in accordance with paragraph B g. Prepayment history of the loans (if seasoned) h. Expected prepayment performance in varying interest rate scenarios. > Estimating the Remaining Balance under the Last Dollar Designation A When the hedged item is designated and accounted for pursuant to paragraphs (b)(2)(v) and A, an entity must validate on an ongoing basis that the last dollar amount designated as the hedged item will be outstanding at the end of the life of the hedging relationship B This analysis must be completed in conjunction with subsequent assessments of effectiveness that are performed in accordance with paragraph C On the first testing date that an entity cannot support the last dollar amount designated as the hedged item to be outstanding on the stated maturity of the hedging relationship, the hedging relationship must be immediately discontinued and accounted for in accordance with Section D At each reporting date, a reporting entity may need to allocate the remaining gain or loss on the hedged item attributable to the hedged risk to the closed portfolio. A report entity may do that allocation on a portfolio basis, or on an individual asset basis to all the remaining assets in the closed portfolio. A reporting entity shall perform such allocations on a reasonable and consistent basis. Derecognition > Discontinuing Hedge Accounting > > Hedged Item Is a Closed Portfolio of Prepayable Assets or a Beneficial Interest in Prepayable Assets For a hedging relationship in which the hedged item is a closed portfolio of prepayable assets or a beneficial interest in a portfolio of prepayable financial instruments as described in (v), the hedge shall be discontinued prospectively, pursuant to paragraph , if a reporting entity can no longer support that the last dollar amount will be outstanding at the stated maturity of the hedging relationship based upon Page 6 of 7

7 DRAFT current expectations of the portfolio or collateral performance pursuant to A through 35-7C If, at the testing date, the outstanding principal amount of the closed portfolio (or beneficial interest) is not greater than the documented last dollar amount, the reporting entity shall cease hedge accounting and not recognize the changes in fair value of the hedged item after the last date on which compliance with the criteria in A was established. If a reporting entity determined that the criteria in A should have precluded hedge accounting in a prior period, the guidance on error corrections in Topic 250 shall be applied to the difference between the results recorded from applying hedge accounting and the results of not applying hedge accounting for those periods where compliance was not achieved. Page 7 of 7

8 Board Meeting Handout Consolidation Initial Deliberations and Pre-Agenda March 8, 2017 PURPOSE OF THIS MEETING 1. The purpose of this decision-making Board meeting is for the staff to present three issues described in the following paragraph, including a summary of feedback received at the December 16, 2016 public roundtable meeting for each issue. The staff intends for the Board to add the last two issues to the technical agenda and for the Board to finalize deliberations on all three issues at today s Board meeting. The staff will ask the Board for permission to begin drafting a proposed Accounting Standards Update (encompassing all issues discussed) for external review. Additionally, the staff will discuss transition, transition disclosures, and next steps. 2. The first issue is the reorganization and clarification of Topic 810, Consolidation. The staff has learned that stakeholders broadly support reorganizing the consolidation guidance currently within Topic 810 into a separate Topic because guidance as currently organized is difficult to navigate. This separate Topic would have separate Subsections for variable interest entities (VIEs) and voting interest entities (VOEs). Public Roundtable Feedback 3. Eight participants (five practitioners, two preparers, and a stakeholder representative) who commented on the proposed reorganization in the staff draft generally support the proposed reorganization of consolidation guidance into a new Topic (812) with separate Subtopics for VIEs and VOEs because it would make the guidance easier to navigate and understand. One participant expressed a desire for a single consolidation model. The staff prepares Board meeting handouts to facilitate the audience's understanding of the issues to be addressed at the Board meeting. This material is presented for discussion purposes only; it is not intended to reflect the views of the FASB or its staff. Official positions of the FASB are determined only after extensive due process and deliberations. Page 1 of 7

9 4. In terms of the use of double negatives in Topic 810, two participants (one preparer and one practitioner) commented on the rewording of the guidance for determining whether an entity is a VIE or a VOE as written in the staff draft. The preparer asked that consideration be given to whether the rewording would cause confusion because the guidance generally has been applied for a long period while the practitioner asked that the guidance be reevaluated to ensure all double negatives are eliminated, to the extent possible. 5. Seven participants (six practitioners and a preparer) agreed with removing the controlled by contract guidance from the Topic on consolidation. All of those participants stated that they were unaware of whether this guidance was still being used in practice but suspected that it may be used by not-for-profit (NFP) organizations. Subsequent outreach with practitioners indicated that the guidance is indeed being used, albeit sparingly, by NFPs. 6. The staff draft provided to roundtable participants included amendments to expected (definitions, determining variability and variable interests, sufficiency of equity, and other areas) to stress that any analysis that included expected must be qualitative in nature and a quantitative analysis could support the overall analysis but not be the sole determinant. All participants commenting on the proposed amendments (six practitioners, a financial reporting advisor, and a stakeholder representative) oppose the changes. Generally, those respondents emphasized that the current guidance is understood and that the quantitative test (including inputs to a quantitative test of expected) is sometimes needed to reach conclusions. They acknowledged that qualitative assessments are inherent in any quantitative analysis but that changing the guidance and restricting stakeholders would constrain analyses, such as determining whether sufficient equity exists in a legal entity. Page 2 of 7

10 Questions for the Board 1. Does the Board have sufficient information to consider proceeding with the proposed reorganization of Topic 810? 2. If not, what additional information does the Board need? 3. Does the Board think that the guidance in Topic 810 for Entities Controlled by Contract should be moved to Topic 958, Not-For-Profit Entities? 4. For concept of expected, does the Board support Alternative A, which proposes not to provide any further clarification to the concept? If no, what clarifications to expected does the Board wish to include in the proposed reorganization of Topic 810? Private Company 7. In applying VIE guidance to entities under common control, private company stakeholders assert that the VIE guidance in Topic 810 is overly complex and difficult to apply. Public Roundtable Feedback 8. Overall, feedback from the roundtable participants was mixed about whether a scope exception from applying VIE guidance should be permitted for private companies under common control. Three practitioners oppose a private company scope exception. Those participants stated that there should be limited accounting recognition and measurement differences between public business entities (PBE) and private companies because creating differences between the two can cause complexity, especially for private companies that may become a PBE in the future. Additionally, these participants expressed concern that entities may structure arrangements to exploit the scope exception to prevent consolidation conclusions. One practitioner supported the scope exception and stated that the scope exception was appropriate because the cost of a determining whether an entity is a VIE does not justify the benefits to the users of private company financial statements. Page 3 of 7

11 9. Other roundtable participants who commented on this issue either support or do not oppose a private company scope exception for entities under common control. Those participants acknowledged that the VIE guidance is difficult for private companies to apply. The participants also mentioned that the current guidance is not applied consistently across entities, and the proposed disclosures would decrease diversity in practice while also providing relevant and useful information to users of financial statements. 10. The scope exception as proposed in the staff draft would require a reporting entity, the common control parent, and all entities under control of the parent to be private companies. Roundtable participants discussed whether all entities under the common control parent must be private companies for the scope exception to apply. They questioned why a public sibling entity should prevent a private reporting entity from applying the scope exception, especially in cases in which a public sibling entity does not transact with the reporting entity and the entity in question for consolidation. 11. Other feedback received was that amendments to the related party guidance in Topic 810, as discussed in issue c below, would not sufficiently address the VIE issues currently affecting private companies under common control. Questions for the Board 5. Does the Board want to pursue a scope exception for private companies in common control arrangements (add a project to the Board s technical agenda)? 6. Should the scope exception for private companies permit the reporting entity to be under common control of a public business entity? 7. Should the scope exception for private companies permit sibling entities under common control to be public business entities? 8. Should the scope exception for private companies permit the legal entity (that is, the entity being evaluation for consolidation) to be a public business entity? 9. Should the scope exception for private companies be extended to all common control arrangements? In other words, should the scope exception Page 4 of 7

12 permit the reporting entity (that is, the entity evaluating the legal entity for consolidation) to be a public business entity? 10. Should the scope exception be elective? 11. Do the proposed disclosures provide sufficient information? If not, what amendments would you propose? 12. How would the Board like to proceed with the leases common control scope exception provided under the private company alternative in Accounting Standards Update No , Consolidation (Topic 810): Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements? 12. For targeted improvements to common control arrangements, Accounting Standards Update No , Consolidation (Topic 810): Interests Held through Related Parties That Are under Common Control, amends the related party guidance within Topic 810 for only single decision makers. Specifically, single decision makers would now consider indirect interests held by related parties under common control on a proportionate basis, as opposed to the equivalent of a direct interest. The amendments in Update make the related party considerations for single decision makers under common control consistent with indirect interests held through other related parties not under common control. 13. During the redeliberations of Update , several stakeholders requested that the Board address the interaction of the changes made in the proposed Update and the application of fees paid to decision makers, the related party tie-breaker analysis, and guidance on most closely associated with. The Board felt it more efficient to issue the final Update and explore additional questions in a separate initiative. Fees Paid to Decision Makers Guidance 14. Most of the roundtable participants provided feedback that was consistent with that received during the comment process for Update Specifically, those participants stated that indirect interests held by a decision maker should be considered on a proportional basis (and not in their entirety) when determining Page 5 of 7

13 whether the decision-making fee is a variable interest. If the decision-making fee guidance considered related party interests proportionally and not in full, this guidance would be aligned with the changes made in Update to the guidance for determining the primary beneficiary of a VIE. Those same roundtable participants asserted that it seems inappropriate to think differently about how indirect interests are evaluated when determining whether the decision-making fee is a variable interest as compared with the primary beneficiary determination. Related Party Tie-Breaker and Substantially All Guidance 15. Two practitioners supported removing the related party tie-breaker test and broadening the Substantially All guidance as an anti-abuse provision. However, those practitioners requested that the staff further clarify factors to consider when evaluating whether a decision maker is acting on behalf of the non-decision maker (or investing entity) in a common control arrangement. Two practitioners and one preparer oppose removing the related party tie-breaker test primarily because the current related party guidance results in appropriate consolidation conclusions and because structuring opportunities may be more prominent if the guidance is removed. 16. Two other practitioners noted that they currently do not see the related party tiebreaker test applied often in public company arrangements. Another preparer supports the removal of the related party tie-breaker test because the guidance is overly complicated and inoperable. Questions for the Board 13. Based on the alternatives proposed by the staff for Issues 1 and 2, does the Board want to add a project to its technical agenda to make targeted improvements to the guidance dealing with common control arrangements? 14. Does the Board want to align the Fees Paid to Decision Makers to the Primary Beneficiary guidance? This would require removing the penultimate sentence of paragraph D, thereby requiring decision makers and service providers to consider indirect interests on a proportional basis when determining whether their fees are variable interests. The penultimate sentence of paragraph D states that Page 6 of 7

14 indirect interests held through related parties that are under common control with the decision maker should be considered the equivalent of direct interests in their entirety. 15. Does the Board want to amend the related party tie-breaker test to provide further clarifications and reduce the diversity in application? If so, which alternative proposed by the staff would the Board prefer? 17. Additional questions for transition and transition disclosures are as follows: Questions for the Board 16. What transition requirements do the Board prefer? 17. What transition disclosures do the Board prefer? Page 7 of 7