Banks, Companies Welcome New Derivatives, Hedge Accounting Rules

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By Steve Burkholder

Banks and industrial companies are welcoming new rules on derivatives and hedge accounting that could help prevent swings in earnings and are likely to provide significant new business for banks.

Agribusiness, the transportation sector, oil and gas producers and companies that use metal in manufacturing and those that sell metal also are likely to benefit from the rule changes issued Aug. 28, accounting rulemakers say.

The new standard, ASU 2017-12, relaxes constraints on commodity price risk-cutting through use of derivatives and business-friendly hedge, or deferral, accounting that keeps gains and losses in derivatives out of earnings.

The Financial Accounting Standards Board rules also hold prospects for eventual higher earnings and increasing stock price-to-earnings multiples, according to Morgan Stanley analysts.

“I am really happy to see the FASB make some much-needed changes to the hedge accounting model,” Muneera Carr, chief accounting officer and controller of Comerica Bank, said Aug. 24, four days before the rules’ release. “I think it is great that companies will be able to manage the risk on their balance sheet without accounting being an impediment or a challenge.”

General Electric Co. global technical controller Russell Botha said he echoed Carr’s words.

“There’s no longer this concept that, for risk management, I want to do something, but for accounting, I might need to designate or document it slightly differently,” Botha said in a webinar held by hedge accounting adviser Chatham Financial, in which Carr also spoke.

Cuts Risk From Price Changes

The “targeted improvements” to complex, 19-year-old derivatives accounting rules, ASC 815, are aimed at better aligning accounting with companies’ efforts to manage risk of adverse price changes in non-financial items, such as raw materials and ingredients, FASB said in issuing the standard. They also refine and expand hedge accounting for financial risks.

The amended rules, which reflect a relaxation of difficult rules on documenting that derivative-based hedges are effective in reducing risk, likely will make financial instruments such as interest rate swaps more appealing to banks and other companies.

The appeal stems from the new rules encouraging enterprises to focus on lessening exposure to interest rate changes, for example, rather than having to worry about credit risk stemming from prepayments of loans held by banks in large portfolios.

Hedge accounting for partial terms of fixed-rate debt instruments also are allowed.

Induce More Hedging

Botha thinks that the rules will allow companies to hedge more. “They’ll be able to get more into hedge accounting, and they will have less ineffectiveness,” Botha said.

Such “hedge ineffectiveness” contributes to volatility in profit and loss from a hedging transaction that might not come to fruition one or two years from when a company buys a derivative to offset a future purchase of a raw material or fuel used in its business, for example.

“And that has to be a win for investors as well. The results will be much easier to explain,” Botha said.

“Companies and investors alike have expressed overwhelming support for this long-awaited standard,” FASB Chairman Russell Golden said in a prepared statement.

The rules have an effective date of January 2019 for public companies. However, many companies have signaled that that they want to take advantage of an option to apply the standard early, FASB officials have said.

Some accountants say it is likely that most companies who want to apply the rules sooner rather than later will have to do that in the fourth quarter or in 2018.

Systems changes will have to be made and internal controls over financial reporting, which check accounting judgments made under the new rules, will have to be put in place, Kevin Kispert, a partner in Ernst & Young LLP’s Professional Practice Group, said in the Aug. 24 webinar.

Michael Gullette, American Bankers Association’s senior vice president for accounting and tax, told Bloomberg BNA that the new standard “appears to be FASB’s best attempt to get hedge accounting as it was always meant to be.”

Smaller Banks to Use Derivatives?

Gullette said a few of ABA’s small bank members of ABA suggested to him that “they might now start considering using derivatives in the first place to control interest rate risk,” when they hadn’t used derivatives before..

Gullette, Morgan Stanley accountant-analyst Todd Castagno, and rulemakers also predicted that the rules will create opportunities for new commerce by banks. New derivatives used to hedge require counterparties, with banks filling those roles, lead to transaction fees, including for broker-dealer arms of banks.

“This opens up a lot,” Gullette said Aug. 28. “I think it does open a lot of opportunity.”

Cautionary Note

Lynn Turner, a former chief accountant of the Securities and Exchange Commission, urged caution by recalling what he described as a relaxation of derivatives rules that FASB issued in 1998. That was only about three to four years after big derivatives scandals at such companies as Procter & Gamble Co., Gibson Greeting Cards, Bankers Trust and fallen German industrial giant Metallgesellschaft AG.

“Now the question arises as to whether the relaxation in the rules will again result in such abuses,” Turner told Bloomberg BNA.

To contact the reporter on this story: Steve Burkholder in Norwalk, Conn. at

To contact the editor responsible for this story: S. Ali Sartipzadeh at

For More Information

The new FASB standard on hedge accounting and derivatives is available at

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