March 9, 2018
Some companies have opted to early adopt the new hedge accounting standard, particularly banks, even though they’re still dealing with other new accounting standards.
The Financial Accounting Standards Board issued its hedging standard last August, making it effective for public companies in 2019 and private companies in 2020, but also allowing for early adoption.
The standard refines and expands hedge accounting for both financial risks, such as interest rates, and commodity risks. The goal was to create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes, for investors and analysts. Many public companies are still trying to adjust to the new revenue recognition standard that took effect in December and the leasing standard that takes effect at the end of this year, not to mention the credit loss standard that’s set to take effect at the end of 2019. The hedging standard might seem almost like an extra burden, but it actually makes life easier for some companies, particularly multinationals, and comes with certain financial benefits.
“Most people felt like this standard was going to be a really big deal for the banks and just for the banks, but we’ve actually had a lot of activity with multinationals across industries,” said Jon Howard, a senior consultation partner at Deloitte. “If they have subsidiaries in Europe, Great Britain or Japan, right now the timing is right for some of the derivative products as far as pricing that they can get because of the cross-currency basis spread, and the difference in interest rates overseas versus here. With forwards and cross-currency interest rate spreads, the pricing is just good if you’re a U.S. company trying to hedge your subsidiary overseas. You’re basically going to be on the receiving end of net interest payments on the swap, or the forward rates are lower than today’s current exchange rates just because of those factors.”
In addition to the advantageous timing, FASB also made some attractive changes to how companies can account for net investment hedges.
“They really simplified what we call the spot method to get rid of the volatility in the fair value of those, so you’ve really got a much more predictable financial accounting result,” said Howard. “If it’s across a currency swap, you’re recognizing the settlements you get on that swap, the kind of interest payments you get through the life of the swap in earnings, and all of the changes now in the exchange rates as they relate to that subsidiary. That goes into equity to offset your translation of the subsidiary.”
The changes made in the accounting standards update eliminate some of volatility of changes in the cross-currency spread. “Any changes in the fair value of that had to go through the P&L to be applied with the spot method,” said Howard. “So it’s really simplifying how that method works and getting rid of the volatility under the ASU, combined with the fact that because rates generally speaking are lower in Japan and in Europe than they are in the U.S., the pricing on these is beneficial in the derivatives market right now. The cross-currency basis spreads are bigger than they typically have been.”
Not only banks are early adopting the new standard, but Howard also sees some early adoption in global manufacturing, retail and high-tech companies. “Whether you’re on the production side or the sales side, if you have operations all around the world, and if you have operations in Europe or Japan, it almost doesn’t matter what sector you’re in,” he said. “If you have significant subsidiaries over there, and significant net assets over there, these are the companies that are getting picked.”
Even though there’s a glut of major accounting standards taking effect over the next few years, he believes the hedging standard is one to consider using a little ahead of time. “My observation so far is that people usually are a little bit leery of new accounting standards coming out,” said Howard. “When they hear you can early adopt, they sometimes pause. I know we’ve got rec rec and we have leasing going on, but the ones that are early adopting I think are finding it to be maybe not as difficult as they thought it would be to early adopt the standard.”
The credit loss standard is also one that many banks and financial services firms are preparing to adopt. “I think people are looking at leases today, and people are also looking at CECL, the credit loss standard, as well,” said Alex Wodka, a partner at Crowe Horwath. “Some entities are beginning to assess what the approach to their implementation is. I think leasing probably will be a more mechanical process. Depending upon the nature of the entity and the number of leases it has, it could be time consuming. For other entities, it may not be so significant. As far as CECL is concerned, it’s going to be one standard that is going to significantly affect the financial services industry in particular.”
However, companies should be aware they do have some one-time elections they will have to make whenever they decide to adopt the hedging standard. “The bigger your hedging book is today, the more things you need to think about because when you adopt there are a lot of one-time elections,” said Howard. “On one hand, we’re encouraging people to make sure that they have a thoughtful early adoption so they don’t miss out on anything because they’re allowed one-time elections. But, that being said, for companies that don’t have a lot going on already, it’s not as significant of an undertaking. This isn’t like adopting the revenue recognition standard where you have a lot of transactions you have to adopt. Hedge accounting is okind of putting their feet back in the water.”