The Financial Accounting Standards Board (FASB) recentlyreleased a long-awaited exposure draft proposing changes to ASC 815, the rules thatgovern hedge accounting. The release was met with enthusiasm frommany hedge accounting experts.

“This is the best thing that has happened to corporate hedgingin decades,” says Helen Kane, founder and president of hedgeaccounting software and consulting firm Hedge Trackers.

As expected, the proposed changes would enable a company to usespecial hedge accounting for component hedging of both financialand non-financial risks. This means that a corporate commodityhedger, for example, could use special hedge accounting for aderivative that mitigates only a portion of the overall risk thatthe commodity poses to the company. Under current rules, specialhedge accounting is allowed only if the financial instrumentsuccessfully protects against the entire risk the commodity posesto the organization.

Kane gives an example of how this change might affect amanufacturer: “Suppose Company A contracts with a fabricator tomake a variety of parts out of aluminum,” she says. “The agreementmight specify that the price for one part will be the cost ofaluminum plus 57 cents. Another part will cost aluminum plus 35cents. And a third part will cost aluminum plus $1.50.”

Today, if Company A used a derivative to guard againstfluctuations in aluminum prices, it might not qualify for specialhedge accounting, because the derivative couldn't protect againstevery financial risk posed by this contract. “If the mix changed,or the spread changed, or you hadn't accounted for changes intaxes, you would end up with ineffectiveness,” Kane explains.“There are so many components that go into a company's overallfinancial risk that even businesses which seem to havestraightforward risks can't always get special hedgeaccounting.”

Under the rule changes in the exposure draft, however, Company Awould qualify for special hedge accounting for derivativespurchased to mitigate its exposure to the price of aluminum.Although this change is applicable to companies engaged in any typeof derivative hedging, it would likely have the largest impact oncommodity hedgers. “I think this change may have come about, inpart, because of all the non-GAAP reporting by commodity hedgers,”Kane speculates. “The old rules don't really invite them toplay.”

Another significant change introduced in the new exposure draftis a reduction in effectiveness testing. Under the proposed rules,the initial quantitative test of hedge effectiveness at the hedge'sinception is now due before quarterly financial results arereported, not within two business days. And after this initialquantitative test, the company would be required to perform onlyqualitative effectiveness tests at the end of each financialreporting period.

Somein the industry had hoped that businesses wouldn't be required toengage in any type of ongoing tests of hedge effectiveness. “Butit's much better to go to a qualitative test after the initialquantitative test,” says Kane. “Basically, companies will just haveto demonstrate that they're still paying attention. For example, inan interest rate scenario they'll have to attest regularly thatthey've looked at the relationship of the swap to the debt, andthat the tenors are still aligned.”

The trick for corporate hedgers may be remembering to providethe appropriate initial assessments now that the timing is moreflexible. “Right now, there's really a race to get initialeffectiveness testing done within a two-day period,” Kane says.“I'm a little concerned people will forget to take care of it ifthey leave it till quarter-end.”

When it comes to changes around disclosure rules, the exposuredraft would actually create more work for some corporate hedgers byrequiring “added guidance on qualitative disclosure of quantitativehedging goals.” In addition, “companies have to change theirtabular formats to show the impact of derivatives on specific linesin the financial statements,” Kane says. “So if you havederivatives gains and losses, and some were from currency, somefrom commodities, and some from interest rates—but all for somereason are hedging the revenue line—then you'll need to show eachof these on a single line in the table. There aren't a lot ofcompanies outside the financial services sector that will have todo this.”

Act Now

Now that the exposure draft is available, the ball is incorporate hedgers' court. The FASB's75-day comment period ends November 22. Kane encourages allcompanies that either currently use derivatives for hedging, or areconsidering hedging in the future, to review the exposure draft andthen let the FASB know how the proposed changes would impact theusers of their financial statements.

“Often companies will comment when they are opposed to rulechanges,” Kane says. “In this case, the proposed changes wouldprovide some excellent benefits. We believe that this guidancewould make special hedge accounting much more accessible tocompanies that have market risk but have been afraid of specialhedge accounting. But without receiving that kind of feedback, theFASB might not realize the extent to which companies would benefitfrom these changes, and it's possible some of the favorableproposed changes wouldn't make it into the final draft.”

For corporate treasurers who are prepared to submitcomments, the FASBprovides an electronic feedback form. Kane cautions thatcommenters wanting to have the most impact should keep in mind theFASB's perspective on hedge accounting.

“The FASB is less concerned about how much work hedge accountingcreates for corporate hedgers, than about the impact on users ofcorporate financial statements,” she says. “Treasurers who arecommenting need to put themselves in the shoes of their board andtheir shareholders, the people who are receiving information aboutthe effectiveness or ineffectiveness of the company's hedgingrelationships.”

FASB commenters should consider the materiality of numbers beingreported under the current regime, versus reporting under theproposed guidelines. Commenters should also think about whether,under the current regulatory regime, their investors, board, andsenior management fully understand the implications of arestatement of financials related to hedge ineffectiveness. “WhenFannie Mae had to issue a restatement back in 2006, to recognizebillions of dollars in losses on derivatives used to hedge interestrate risks, they obviously took a hit to their P&L,” Kane says.“But how many people reading the financial statements realized thatFannie Mae's earnings were going to look better than cash for theforeseeable future? Probably not many.

“We're hoping corporate treasurers will let the FASB know whatchanges to current hedge accounting rules would be meaningful fortheir shareholders and for internal management,” Kane says. “We'realso hoping they will communicate whether—and why—some of theinformation that they've been tediously collecting hasn't beenmeaningful.”

In particular, Kane encourages corporate hedgers to providefeedback on the “questions for respondents” starting on page 8 of the exposure draft. “These are the areas in which theFASB is actively looking for input,” she says. “The questions won'tall be relevant to every company. But it would be wise to determinewhich of these questions are applicable to your organization andprovide feedback on those.”

How many comments the FASB receives, and the degree to whichthose comments require rethinking of some of the proposed rulechanges, will determine when the final rule changes are released.Kane expects the final rules to come out sometime in 2017, perhapsin the first half of the year.

Early adopters will be able to make the switch as soon as thebeginning of the next quarter after the rules are finalized, withthe effective date (required implementation date) to follow. So thefirst companies may be using the new rules before the end of2017.

That should be good news for corporate shareholders, managers,and treasury teams alike.