While the Financial Accounting Standards Board's recent proposalon accounting for financial instruments has irked the bankingindustry by extending fair-value accounting to loans, another partof the draft could ease the chore of accounting for hedges forother companies.

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“There are some elements that will make hedging a little biteasier,” says Tom Omberg, the Deloitte & Touche partner wholeads the firm's financial accounting and reporting servicesoffering.

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Under FAS 133, Omberg explains, companies that didn't use theshort-cut or match-terms methods to establish the effectiveness ofa hedge had to perform a quantitative assessment of a hedge'seffectiveness.

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“Those calculations could be difficult to do,” he says. “Theyhad to be done at inception and every quarter. When you closed thebooks, companies had to go back and check effectiveness.”

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Under the proposed changes, “all you have to do is assert at theinception of the hedge that you expect it to be reasonablyeffective,” he says. And that assertion can be based on qualitativeanalysis, Omberg says, which might include considering thehistorical relationship between the hedging instrument and theposition to be hedged, or the maturity date of the hedginginstrument and a security being hedged.

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Helen Kane, founder and president of Hedge Trackers, aderivatives accounting consulting company in Cupertino, Calif.,says FASB's proposed changes will eliminate “a lot of busyworkaround effectiveness testing.”

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“What they're saying is when there's an obvious economic linkbetween the derivative and the underlying, don't spend a lot oftime on proving how that relationship works,” Kane says. “Focusinstead on where the difference will be going forward in these cashflows, so you can capture the ineffectiveness.”

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That poses a new challenge for corporate hedgers, she says. “Idon't believe a lot of companies have focused really a solid efforton capturing the ineffectiveness in the current relationship.”

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FASB's proposal would require that hedges be “reasonablyeffective” to qualify for hedge accounting treatment, rather thanthe “highly effective” standard it previously cited. And it hasproposed eliminating the short-cut and match-terms methods ofestablishing hedge effectiveness.

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“For anyone who uses short-cut or match-terms, this isdefinitely not going to be easier,” Kane says. But Omberg notesthat companies have used the short-cut method less frequently inrecent years “given the rigid criteria.”

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One hitch for companies that use hedge accounting is that FASB'sproposed changes would no longer allow them to de-designate hedges,that is, stop use hedging accounting for a position. “Under currentaccounting rules you can designate and de-designate a hedgewhenever you want,” Omberg says. “The proposal that's out therewould not allow you to de-designate a hedge until it was no longereffective.” That change “will limit your ability to do dynamichedging,” he says.

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Kane says companies that hedge their inventories or contractsmight have a problem if they're not able to de-designate, sinceinventories fluctuate and contracts are altered, situations thatcompanies dealt with in the past by de-designating hedges. “Itwould become very difficult for inventory hedges,” she says. “I'mnot sure how those folks would address the changing values.”

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So which companies would benefit? Those that “have a number ofhedges that were more static hedges–put on with the intention ofhedging to the maturity of the asset or the liability–and weren'tusing the short-cut method will probably find the proposal to behelpful,” Omberg says. “Companies that do dynamic hedging are goingto find the provisions that preclude de-designation to be aproblem, and they're going to have to explore how to hedge a poolof assets.”

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To read about the congressional battle over regulatingderivatives, see Rock Solid on OTC Derivatives Regs.

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Susan Kelly

Susan Kelly is a business journalist who has written for Treasury & Risk, FierceCFO, Global Finance, Financial Week, Bridge News and The Bond Buyer.