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Update on FASB's Hedging Rules

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Update on FASB's Hedging Rules Update on FASB’s Hedging Rules In 2017, FASB issued Accounting Standards Update (ASU) 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The amendments made targeted—but substantial—changes to better align hedge accounting with management’s risk management activities and reduced the cost and complexity of applying hedge accounting. Many companies took advantage of early adoption, giving rise to several implementation and operational questions that FASB recently addressed in a set of technical corrections, ASU 2019-04. Hedge accounting is an option and will continue to be a somewhat difficult area for preparers, auditors and users, notwithstanding the recent simplifications. FASB has a separate project underway covering the “last-of-layer” method, which makes it easier to hedge prepayable financial instruments. This project is in the initial deliberation stage, and no time frame is set for an exposure draft. FASB also has added a project to address the operational challenges of migrating to a new benchmark rate once the London Interbank Offered Rate (LIBOR) is phased out in 2022. Removing and replacing LIBOR will be complicated with the biggest effect on long-dated contracts with a maturity after the phaseout. For derivatives contracts, master agreements between counterparties likely will have to be amended or replaced. Retail mortgages, home equity lines of credit and any other consumer or business debt tied to LIBOR may have to be amended unless a back-up interest rate index is referenced in the original documentation. Mortgage-backed securities, loans and floating rate bonds all tied to LIBOR will have to be addressed contractually and—with regard to deal-specific covenants—may require consents from the owners of these securities. Relief will be needed from the requirement to dedesignate an existing hedging relationship and redesignate a new hedging relationship as a result of a change in any of the critical terms. A change in either the fallback provision or the contractual variable rate of LIBOR-based contracts would be considered a change in the critical terms of the hedging relationship, indicating that a dedesignation would be required. PBEs All Others Interim and annual Effective Date Annual statements statements beginning after ASU 2017-12 beginning after December 15, 2019 December 15, 2018 Partial-Term Fair Value Hedges of Interest Rate Risk Stakeholders asked whether the ability to measure the hedged item in a partial-term fair value hedge using its assumed maturity date applies only to interest rate risk or whether the hedged item in a partial-term fair value hedge of both interest rate risk and foreign exchange risk also can be measured using the assumed partial-term maturity date. Can multiple partial-term fair value hedging relationships of a single financial instrument be outstanding at the same time? An entity may measure the change in fair value of a hedged item using an assumed term only for changes attributable to interest rate risk. Measuring the change in fair value of a hedged item attributable to interest rate risk using an assumed term does not preclude the same cash flows from also being designated in a hedge of foreign exchange risk. In a forward-starting partial-term hedge, an entity may assume a forward issuance date for Update on FASB’s Hedging Rules the hedged item that coincides with the date in which the first hedged cash flow begins to accrue. One or more separately designated partial-term fair value hedging relationships of a single financial instrument can be outstanding at the same time. Amortization of Fair Value Hedge Basis Adjustments Is the amortization of a fair value hedge basis adjustment required for outstanding fair value hedging relationships? What is the amortization period to be used when amortizing the basis adjustment in a partial-term fair value hedging relationship? An entity may—but is not required to—begin to amortize a fair value hedge basis adjustment before the fair value hedging relationship is discontinued. If an entity elects to amortize the basis adjustment during an outstanding partial-term hedge, that basis adjustment should be fully amortized on or before the hedged item’s assumed maturity date. Disclosure of Fair Value Hedge Basis Adjustments Stakeholders asked for clarification of the fair value hedge basis adjustment amounts required to be disclosed. Should hedged available-for-sale (AFS) debt securities be disclosed at amortized cost or fair value? Should basis adjustments related to foreign exchange risk be disclosed? AFS debt securities should be disclosed at their amortized cost and fair value hedge basis adjustments related to foreign exchange risk should be excluded from the required disclosures. Consideration of the Hedged Contractually Specified Interest Rate Under the Hypothetical Derivative Method Should an entity consider the contractually specified interest rate designated in the hedging relationship when applying the hypothetical derivative method? An entity should consider the contractually specified interest rate being hedged when applying the hypothetical derivative method. Scope for Not-for-Profit (NFP) Entities Can an NFP that does not separately report earnings elect the amortization approach for amounts excluded from the assessment of effectiveness under fair value hedge accounting? An NFP that does not separately report earnings may not elect the amortization approach for amounts excluded from the assessment of effectiveness for fair value hedging relationships. Hedge Accounting Provisions Applicable to Certain Private Companies & NFPs ASU 2017-12 provided timing relief on the documentation of the analysis supporting a last-of-layer hedge designation to certain private companies that are not financial institutions. When is a private company that meets the criteria required to document the analysis supporting a last-of-layer hedge designation? Does the same timing relief related to subsequent quarterly hedge effectiveness assessment provided to certain private companies in paragraph 815-20-25-142 apply to hedging relationships of NFPs (except for NFP entities that have issued—or are a conduit bond obligor for—securities that are traded, listed or quoted on an exchange or an over-the-counter market)? 2 Update on FASB’s Hedging Rules A private company that is not a financial institution should document the analysis supporting a last-of-layer hedge designation concurrently with hedge inception. NFPs (except for NFPs that have issued—or are a conduit bond obligor for—securities that are traded, listed or quoted on an exchange or an over-the-counter market) have the same relief on a subsequent quarterly hedge effectiveness assessment. Application of a First-Payments-Received Cash Flow Hedging Technique to Overall Cash Flows on a Group of Variable Interest Payments ASU 2017-12 removed the implementation guidance and illustration demonstrating the application of the first- payments-received cash flow hedging technique to overall cash flows on a group of variable interest payments. Do those deletions indicate such a technique no longer is permitted? The application of the first-payments-received cash flow hedging technique to overall cash flows on a group of variable interest payments continues to be permitted. Transition Guidance ASU 2017-12 offered certain one-time elections to allow entities to apply the amendments to existing hedging relationships. The ASU, as written, indicated transition adjustments to amend the measurement methodology of the hedged item in a fair value hedge of interest rate risk should be made as of the date of adoption of ASU 2017- 12. This raised several questions: Are other rebalancing approaches—beyond dedesignating a portion of the hedged item—allowed for fair value hedging relationships of interest rate risk when an entity modifies the measurement methodology used for the hedged item from total contractual coupon cash flows to the benchmark rate component of the contractual coupon cash flows? An entity may rebalance its fair value hedging relationships of interest rate risk when it modifies the measurement methodology used for the hedged item from total contractual coupon cash flows to the benchmark rate component of the contractual coupon cash flows by any combination of increasing or decreasing the designated notional of the hedging instrument or increasing or decreasing the designated proportion of the hedged item. However, the entity may not add new hedged items or hedging instruments to the hedging relationship. Can an entity transition from a quantitative method of hedge effectiveness assessment to a method comparing the hedging relationship’s critical terms without dedesignating the existing hedging relationship? An entity may transition from a quantitative method of hedge effectiveness assessment to a method comparing the hedging relationship’s critical terms without dedesignating the existing hedging relationship, if all the related criteria are met. Under ASU 2017-16, an entity may reclassify a debt security from held-to-maturity (HTM) to AFS if the debt security is eligible to be hedged under the last-of-layer method. This election raised three questions: Does reclassification call into question an entity’s assertion to hold to maturity those debt securities that continue to be classified as HTM? Reclassification of some securities would not call into question an entity’s assertion to hold to maturity those debt securities that continue to be classified as HTM. Is a reclassified debt security required to be designated in a last-of-layer hedging relationship? No, a reclassified debt security is not required to be designated in a last-of-layer hedging relationship. Is an entity prohibited from selling the security after reclassification? No, such securities may be sold after reclassification. 3 Update on FASB’s Hedging Rules Transition & Effective Date For entities that have not adopted ASU 2017-12, the effective dates and transition are the same as ASU 2017-12. For entities that have adopted ASU 2017-12, the effective date is as of the beginning of the first annual period beginning after April 2019—the issuance date of ASU 2019-04.
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