The Financial Accounting Standards Board (FASB) has released an Accounting Standards Update (ASU) designed to promote synergy between hedge accounting and an organization’s risk management procedures. The latest ASU builds on the FASB’s 2017 issuance of a hedging standard which improved alignment between the two entities. The earlier standard also increased transparency concerning how results of hedging activities are presented – on the face of the financial statements and in the footnotes – for investors and analysts when hedge accounting is applied.
The 2017 standard introduced the “last-of-layer” hedging method (also referred to as the portfolio layer method). Under the standard, the last-of-layer method enables an entity to hedge its exposure to fair value changes because of shifts in interest rates for a section of the portfolio that is not expected to be impacted by prepayments, defaults, and other activities affecting the timing and amount of cash flows. More specifically, this would pertain to a closed portfolio of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments. Through stakeholders’ comments following the issuing of the standard, the FASB determined that while the ability to choose hedge accounting for a single layer is useful, hedge accounting could enhance alignment with risk management activities if expanded to allow multiple layers of a single closed portfolio to be hedged under the method.
FASB’s ASU introduces the following changes:
recognizes eligible hedging instruments in a single-layer hedge
expands the scope of the portfolio layer method to include nonprepayable assets
provides additional guidance on the accounting for and disclosure of hedge basis adjustments under the portfolio layer method
determines how hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio
provides investors and other allocators of capital with more transparent, decision-useful information around an entity’s use of derivatives
The ASU applies to all entities that choose to use the portfolio layer method of hedge accounting. For public business entities, the ASU is in effect 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 of the ASU is permitted.