FASB Hedge Accounting Exposure Draft: What You Need to Know


On Sept. 8, the FASB released a new Exposure Draft on special hedge accounting, the objective of which is to make hedge accounting more accessible, simpler to achieve and easier to account for, at a greatly reduced risk of restatement.

Hedge Trackers believes that this proposal will greatly benefit hedgers as their focus can return to managing currency, interest rate and commodity risk and away from managing hedge accounting risk. Our first impression of the draft is positive.

The concept of “ineffective amounts” has been eliminated from hedge entries. The entire change in the derivative value will be recorded for:

  • Cash flow hedges directly to OCI and then reclassified to the same line item where the hedged item is recorded when it is recognized in income, or;
  • Fair value hedges directly to the line item where the hedged item is presented.

No longer will companies struggle to calculate the meaningless “amount of ineffectiveness.” Under the proposal, once you qualify for hedge accounting, you are 100 percent effective. And once you qualify for hedge accounting, you qualify for hedge accounting. A quantitative effectiveness testing will still be required at the inception of the hedge, but ongoing prospective and retrospective assessments can be done on a qualitative basis.  All quantitative testing for trades in a period are due by quarter end. There’s no rush to finish the testing contemporaneously anymore, unless you are hedging at quarter end. (There is a caveat should the economic environment change substantially that you may be required to revisit your hedge relationships effectiveness quantitatively.)

The Critical Terms Match (CTM) assumption of effectiveness is back and fortified. Under current GAAP, matched terms mean the derivative maturity and the hedged item’s maturity needs to match “to the day.” FASB now proposes that hedge maturity and exposure maturity need only be “matched” within 31 days, a much lower bar to meet. If you are wrong about the days, you will need to offer a backup test. And for interest rate hedgers, if you take short-cut treatment and the hedged item is found to be not perfect, FASB will now let you use a newly required “back up” test documented at hedge designation. This new latitude eliminates the risk and useless financial results of falling in and out of special hedge accounting.

The exposure draft will be open for a comment period through Nov. 22. We encourage you to participate in the comment process sharing with the FASB how the new proposal will impact the quality of your external reporting

Commodity hedgers have finally been invited to the hedge accounting table under the new proposal. Guidance may shift the hedge results of commodity companies back into GAAP reporting as the FASB opens special hedge accounting to “contractually specified component(s) linked to an index stated in the contract” as the hedged risk. In other words, if your contract pricing is commodity X plus/minus a spread, that commodity X (without the spread) is now hedge-able, and if commodity X is highly correlated to your derivative you get perfect hedge accounting on top of that. So you can now hedge the MMBTU or natural gas element of your energy bills, the nickel component of stainless steel, and/or the diesel cost of your refueling charges as long as those components are contractually specified.

Variable interest rate hedgers will also be able to designate any “contractually specified index rate” in a cash flow hedge relationship. So the concept of “benchmark” risk is replaced with “contractual index risk” in cash flow hedging.

Fixed rate hedges remain tied to the benchmark risk concept, but benchmark risk has been further expanded to include SIFMA. There are additional advantages for the fair value interest rate hedgers with an ability to define the hedged item’s term based on the first and final “hedged” cash flows. As a result the maturity of the “hedged item” equals the final cash flow of the hedge instrument. And to sweeten the deal, hedged callable debt can be modeled to consider only how changes in interest rates (not credit, change in control, etc.) will affect changes in fair value. “Short-term” treatment will be available for partial term fair value hedges.

There are some minor disclosure changes vis a vis content, but major changes to the required disclosure tables. Those hedging a single market risk may be able to continue to present tables in a portrait orientation but those hedging across asset classes are likely required to use a landscaped presentation in their financials.

Takeaways & Next Steps

Overall, we see this proposal as a huge win for those applying hedge accounting and an open invitation to companies who would benefit by applying hedge accounting but have been afraid to jump in. The rules are simplified so there’s more you can hedge, the accounting is easier and the risk of restatement is substantially reduced. The exposure draft will be open for a comment period through Nov. 22. We encourage you to participate in the comment process sharing with the FASB how the new proposal will impact the quality of your external reporting. Let them know what works (e.g., contractual risk, partial term hedging, elimination of measuring and repeated testing of ineffectiveness), and what doesn’t (e.g., landscape oriented tables, discretion in income statement geography of derivative gains/losses).

Adoption will be permitted as early as the first fiscal period following publication of the final ASU. We would expect all hedgers to jump on the bandwagon as soon as possible, but there will be an effective date also published by the FASB in the final ASU that will define the latest period for adoption.

If you have questions or just want to find out how these new hedge accounting rules can help your firm protect margins, call Hedge Trackers at 408-350-8580, or visit hedgetrackers.com.