IAS 39 pushes Europe back to basics

Eight months after the introduction of International Financial Reporting Standards (IFRS), dealers say there has been a discernable impact on the derivatives market, as European firms look to simplify hedging strategies.

Under International Accounting Standard 39, implemented in January, listed European companies are required to mark-to-market their derivatives positions, with any changes in value reported on the profit and loss (P&L) statement. It has already had an impact on the interest rate derivatives landscape, with many corporates, financial institutions and asset managers still coming to grips with the operational and bookkeeping aspects.

"There has been a rush to plain vanilla strategies, similar to what happened after the introduction of Financial Accounting Standard (FAS) 133 in the US in 2001," says Jonathan Chesebrough, director of rates structuring at Royal Bank of Scotland in London.

Some institutional clients have begun to take a more cautious approach when using structured products. In some cases, the embedded derivative has to be removed from the host contract and marked-to-market. "Many financial institutions have very high yield targets, and the way to meet this is to use structured note products," says Chesebrough. "IAS 39 may require some of these enhanced coupons to be split out of the note and accounted for at fair value, which can lead to undesirable P&L volatility."

Corporate treasurers have also shunned complex derivatives in favour of a more basic approach since the new rules were implemented. "Some companies are now trying to make life easier for themselves by asking banks to lend to them at a fixed rate," says Mark Baillie, IFRS specialist at Barclays Capital in London.

However, most market practitioners believe this step away from more complicated derivatives strategies will be temporary. They compare the situation in Europe today to the experience in the US four years ago when FAS 133 was introduced. "Nowadays in the US, there's a lot more derivatives use for asset and liability management than there was immediately after FAS 133 came online," says Bill Grathwohl, managing director and co-head of fixed-income and equities structuring at Goldman Sachs in London.

Rachel Wolcott

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