A new Accounting Standards Update (ASU) aims to better align hedge accounting with an organization’s risk management strategies.
The ASU, released Monday by the FASB, extends the current single-layer hedging model to allow for multi-layer hedges of a single closed portfolio of callable financial assets or one or more beneficial interests guaranteed by a portfolio of financial instruments redeemable in advance according to the method. Due to the expansion, the FASB renamed the last layer methods to the wallet layer method.
The ASU resolves issues raised after the FASB issued a new hedging standard in 2017 that increased transparency about how the results of hedging activities are presented – both in financial statements and their footnotes page – for investors and analysts when hedge accounting is applied.
One of the main provisions of this standard was the addition of the last level hedging method. For a closed portfolio of fixed-rate callable financial assets or one or more beneficial interests secured by a portfolio of callable financial instruments, such as mortgage loans or mortgage-backed securities, the method of the last level allows an entity to hedge its exposure to changes in fair value due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults and other events affecting the timing and amount of cash flow.
After the publication of this standard, stakeholders told the FASB that while the ability to choose hedge accounting for a single layer is useful, hedge accounting might better reflect risk management activities if extended to allow several layers of the same closed portfolio to be hedged according to the method.
The ASU also does the following:
- Expands the scope of the portfolio layer method to include non-callable assets;
- Specifies eligible hedging instruments in a one-level hedge;
- Provides additional guidance on the accounting and disclosure of hedge adjustments under the portfolio layer method; and
- Specifies how hedging basis adjustments should be considered when determining credit losses for assets included in the closed portfolio.
“The extended hedge accounting method better reflects the effects of risk management activities in the financial statements and ultimately provides investors and other allocators of capital with more transparent and decision-useful information about the use of derivatives by an entity,” FASB Chairman Richard R. Jones said. in a press release.
The ASU applies to all entities that choose to apply hedge accounting at the portfolio level. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2022 and interim periods within those fiscal years. For all other entities, the ASU is effective for fiscal years beginning after December 15, 2023 and interim periods within those fiscal years. Early adoption is permitted.
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