New derivatives disclosures will be “significant burden”

Tougher disclosures required by the Connecticut-based Financial Accounting Standards Board (FASB) will be a “significant burden” for companies using derivatives, said Hee Lee, New York-based partner in Ernst & Young’s Financial Services Office and external advisor to the International Swaps and Derivatives Association.

On March 19, the FASB issued a statement regarding Financial Accounting Standard 161 (FAS 161), an amendment to pre-existing disclosure rules contained in FAS 133 and elsewhere. It requires companies to explain how and why they use derivatives, how derivatives are accounted for under FAS 133, and how derivatives and hedged items are affecting their balance sheet and income statements.

Among other things, the statement means companies will have to present tables showing the impact of different types of derivatives contracts on their income statements and balance sheet. In each case, they will have to provide details such as the location of derivatives by asset class, their fair values and whether or not they qualify for hedge accounting.

“Obviously this is a significant burden from a corporate perspective,” said Lee. Nevertheless, he acknowledged the stipulations contained in FAS 161 had been watered down from those originally proposed. In particular, dealers and trading firms managing derivatives on a portfolio basis are able to disclose their exposures differently under the new standards.

The rules move away from previous statements by requiring derivatives disclosures on a gross, rather than net, basis. “The question is how useful this is, because in reality you net your exposures, so it doesn’t really affect the economics,” Lee said. “But based on the proposed standard, this is a much better result.”

FAS 161, which will apply for fiscal years and interim periods beginning after November 15, also enforces disclosures about contingent features of derivatives held by companies, such as requirements to post collateral following a downgrade of their credit rating. It additionally clarifies that disclosures about credit risk concentrations, sought under FAS 107, also extend to derivatives.

The new rules were welcomed by David Zion, accounting analyst in equity research at Credit Suisse in New York. He said a better feel for the risks and rewards of derivatives activity would be helpful to investors. “That’s useful information from an investor’s perspective, which I’d argue in many cases is severely lacking.”

However, he recognised there was a possibility that more stringent disclosure requirements could deter companies from using derivatives altogether. “We would hope that’s not the case, but we know the accounting and the additional disclosures can have an impact,” he said.

In fact, a recent report by Zion and his colleagues highlighted the example of Minneapolis-based food producer General Mills, which recently decided to abandon hedge accounting for its cashflow statements when faced with the cost and complexity of implementing FASB rules. The FASB is now trying to simplify hedge accounting requirements, and is expected to publish an exposure draft on the topic by mid-June.

On March 28, the body published a discussion paper on reducing complexity in reporting for financial instruments more generally, and is taking feedback on the matter until September 19. Meanwhile, it is also considering imposing further disclosures for credit derivatives.

See also: M&B reports £274m hedging loss
Porsche's derivatives success a mystery
FASB suggests more in-depth derivatives reporting