Re: The Association of Corporate Treasurers (‘ACT’) response to the Accounting Standards Board on FRED23 - Financial Instruments: Hedge Accounting
Further to our proposal of suggested amendments to IAS39 submitted on 30 November 2001, the ACT Derivatives Accounting Working Group (‘DAWG’) has developed a response to the issues raised within FRED23. We have included a list of the DAWG members in Appendix 1. Our response detailed in Appendix 2 has been prepared by the DAWG and approved by the ACT Technical Committee. Whilst our response has been endorsed by many of our members, we cannot be certain that it would be representative of the views of the entire membership of the ACT.
We have responded to questions 1 – 7 in the questionnaire, however we would suggest a simpler approach to assist the implementation:
We hope that you find our comments useful and constructive and thank you for having given us the opportunity to comment on this subject. If you wish to discuss further any of the issues raised in our response please contact our technical department at technical@treasurers.org.
Yours sincerely
Jon Boyle
Chairman of the Technical Committee
ACT Derivatives Accounting Working Group
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Jon Boyle Sebastian Di Paola Philip Gillett Terry Harding David Harrison Valerio Pace Joe Peka Lee Perkin Stephen Pugh Nathan Reeve Coje Schmidt Hugh Shields Alain Stangroome John Francis Stewart Helen Wilkinson Wilson Woo |
Fidelity Investments International PwC Belgium ICI KPMG Ernst & Young LLP Lehman Brothers BUPA PwC Economist Deloitte Eurocash KPMG HSBC UBS Zurich ACT EY Singapore |
1. Do you agree that a UK standard on hedge accounting is needed at this time to improve UK accounting and to prevent a gap appearing in UK accounting literature on hedges of net investments in foreign operations?
1A. We believe that it is appropriate to introduce a standard on hedge accounting, which is more in line with both International (IAS39) and US (FAS133/8). The introduction of the proposed accounting principles do support many of the treasury policies, procedures and controls that companies already have in place and will enforce rigorous documentation of hedging activities within a stated risk management framework. Also, we believe it is appropriate to address hedges of net investments in foreign operations within the Standard. However, we do not see any sense in listed companies implementing FRED23 when the implementation of IAS39 will follow on so soon afterwards. If FRED23 were issued in January 2003, there would need to be at least a six-month period before its adoption, say July 2003. Listed companies will need to have made preparations for the implementation of IAS39 from January 2004. Therefore, for listed companies we believe that it is more logical to move straight to IAS39 implementation, rather than to adopt FRED23 approximately six months earlier. One possibility on net investment hedging, in the absence of FRED23, is to include it in FRED24.
2. The ASB has taken the view that, in order to start the process of brining UK practice on hedge accounting into line with the practice adopted internationally, the proposed UK standard’s restrictions on the use of hedge accounting should be based on the main principle that underlies the hedge accounting restriction in IAS39: that hedge accounting should be permitted only if the hedging relationship is pre-designated and meets certain effectiveness criteria.
(a) Do you agree that the UK standard should be based on the principles underlying IAS39 as set out in the FRED?
(a) A. We believe that the principles of IAS39 do promote sound treasury risk management practices and therefore the FRED should be based on IAS39. However, it is important to note that the implementation of a mixed model of cost and fair value accounting will be complicated and costly for many companies.
(b) Does the principle need to be supplemented by any other principles?
(b) A. No.
3. The ASB has taken the view that the UK standard should contain those detailed restrictions in IAS39 that appear to it to be necessary to implement the aforementioned principle, but should not at this stage include any other restrictions on the use of hedge accounting.
(a) Do you agree that the FRED’s proposed restrictions on the use of hedge accounting (see paragraphs 4,6 and 8 of the FRED) are all necessary to implement the aforementioned principle?
(a) A. We believe that the pre-designation, documentation and hedge effectiveness criteria do all need to be applied to implement the aforementioned principle, and in fact many companies are already applying such internal controls already in their hedging activities.
(b) Do you agree that the FRED should not contain any other restrictions on the use of hedge accounting? If not, what should those other restrictions be?
(b) A. We believe that the Standard should define what is meant by “highly probable” in relation to hedging of forecast transactions. We would suggest that cash flows may only be regarded as “highly probable” if anticipated within a company’s formal planning and budgeting cycle.
4. Do you agree with the material in the FRED on measuring hedge effectiveness (see paragraphs 9 – 15 of the FRED)? If you do not, what if any changes would you make to the material (bearing in mind that the material is drawn largely from IAS39 and that one objective of the FRED is to bring about convergence of accounting practice)?
4. A. We agree with the hedge effectiveness testing criteria. We believe a pragmatic approach by companies is required so that they select an appropriate methodology for assessing hedge effectiveness. This should not be detailed within the Standard, as implementation of this aspect will vary widely between companies. However, the Standard should state the requirement for consistent application of methodologies over time (for a single hedge relationship) and across similar hedge relationships.
5. The ASB has taken the view that, in the main, the proposed FRED should not prescribe how hedge accounting should be done. Do you agree with this approach?
5. A. We agree with this approach and believe that each company will implement the Standard differently which is appropriate depending on the level of financial risk, accounting and treasury resources and other factors.
6. The ASB has nevertheless decided that the FRED should propose some minimum requirements on the hedge accounting techniques to be used. Do you agree with the FRED’s proposals on:
(a) the treatment of hedge of net investments in foreign operations (see paragraph 16(a) of the FRED)?
(a) A. Yes.
(b) the treatment of the ineffective portion of a gain of loss on a hedge that is not a hedge of a net investment in foreign operations (see paragraph 16(b) of the FRED)?
(b) A. The principle of ineffectiveness cannot work where the treatment of unrealised gains and losses is asymmetric i.e. losses are recognised, but gains are not. Therefore, for unlisted companies, until changes are made to UK Company Law an interim solution to FRED23 is required.
(c) the treatment of hedging instruments that cease to qualify for hedge accounting (see paragraphs 17 and 18 of the FRED)?
(c) A. The provisions of 17b are unclear and unworkable. If we consider the hedge of a fixed rate debt issue through an interest rate swap: If the swap is terminated, any gains or losses accrued on that swap will never be recognised. The presumption is that there will be a gain/loss on the redemption of the debt, which rarely happens since the debt is issued and redeemed at par.
7. The ASB is proposing that the standard should come into effect for reporting periods ending on or after a date in early 2003, although it is also proposing certain transitional arrangements (see paragraph 20 of the FRED). Do you agree with this approach?
7. A. A transition approach may be appropriate for some Standards but we do not believe that this is the case for FRED23 for the reasons outlined in the cover note.