Two securities industry groups filed a joint comment letter with the Governmental Accounting Standards Board, urging it to ensure it has sufficient resources to assist issuers as they prepare to comply with its proposed accounting and financial reporting standards for derivatives transactions.
The Securities Industry and Financial Market Association and the International Swap and Derivatives Association Inc. filed their comment letter last week in response to the exposure draft of GASB’s new derivatives standards, which was released in July. The comment letter touches on several technical issues, while noting more broadly that GASB must “carefully consider the resources it will make available to assist preparers as the new statement is implemented in practice.”
“If the GASB is not [prepared], we question whether sufficient due process has been put forth by GASB in connection with the issuance of the exposure draft,” the letter said.
Citing “often unforeseen complexities inherent in accounting for derivatives,” the letter compares implementation of the new GASB standards to the implementation of Financial Accounting Standards Board’s Statement 133 on derivatives accounting and financial reporting for corporations, which was fraught with problems.
Randy Finden, GASB’s manager on the project, said the board had taken note of SIFMA and ISDA’s concerns.
“We’re sensitive to that,” he said, noting that the board took the extra step of drafting a preliminary views document last year, which was designed to provide an advance look at the issues that the project addresses.
The board wrote a “plain English” supplement to explain the new standards to users, and officials crisscrossed the country in recent months speaking to industry groups. After the standards are finalized next year, it plans to write an implementation guide, Finden said.
The derivatives accounting standards generally would require states and localities to report the fair value of their derivatives transactions as assets or liabilities in their financial statements, depending on whether the derivatives represented resources or claims on resources, respectively.
Fair value is defined as either the value of the derivative’s future cash flows in today’s dollars or the price it would fetch if it could be sold on an open market. Annual changes in the fair value of the derivatives would be reported in the financial statements as increases or decreases in investment income.
However, if a derivative is being used as a hedge — effectively reducing risk that it was created to address — and is associated with something that is not reported in the financial statements at fair value, such as outstanding bonds, then the annual change would be deferred and would be accumulated in the statement of net assets or balance sheet as either deferred inflows for increases in fair value or deferred outflows for decreases in fair value.
The two groups were critical of GASB’s restrictions on the use of the “consistent critical terms” method for determining whether a derivative is an effective hedge and would qualify for hedge accounting.
They argued that it is unduly restrictive for GASB to restrict using the method for an interest rate swap whose variable payment is based on a benchmark interest rate multiplied by a coefficient, or a benchmark interest rate adjusted by a constant spread.
“Removing this restriction will enable entities that have indeed achieved highly effective hedges to demonstrate such in a qualitative manner without expending a significant amount of cost and resources,” the comment letter said.
But GASB has said the restriction is appropriate because of the basis risk attached to such benchmarks, like the London Interbank Offered Rate and the fact that there’s no guarantee that the relationship between the variable instrument and the hedged swap will remain constant.
