October 1, 2002

FAS 133 Depressed Taste Even for Plain Vanilla, St

BETHESDA, Md. (HedgeWorld.com)--The use of derivatives for hedging purposes has declined over the last year, and the effects of Financial Accounting Standard 133 are a significant part of the reason why.

Those are the chief conclusions of a new report from the Association of Financial Professionals.

AFP mailed an eight-page questionnaire to select corporate practitioner members in May 2002 and received 175 valid responses. The respondents represent companies throughout the United States, with annual revenues between US$1 billion and US$5 billion.

Two-thirds of those companies use derivatives to hedge their interest rates and currency exposures, but only one-third use exposures to address their commodity or raw material price exposures. Nearly a quarter of the respondents said that their company had decided to forego hedge accounting on "significant portions" of derivative positions as a result of FAS 133.

"This result is especially significant as financial professionals already cite an overwhelming reliance and preference for the simplest, most plain vanilla derivatives," said Jim Kaitz, AFP's president and chief executive. "Even on such basic instruments, the respondents are saying that compliance with FAS 133 is difficult."

FAS 133 required companies to account for derivatives on their balance sheets at current market value, which has brought many transactions that were previously off the balance sheet onto it, creating the potential for increased volatility in reported earnings.

As early as the spring of 2001, Christopher Pieszko, senior vice president and corporate controller of MacDonald's Corp., observed that such an impact was already underway. Interviewed for Financial Executives magazine, he said that MacDonald's has "had to change the way we actually run the business in terms of financing."

MacDonald's, which of course operates around the globe, is naturally concerned about currency shifts. But "the instruments that we had in place that were effective for us under the old rules in terms of hedging and currency management had to change. We've modified our portfolio significantly to reduce any P&L volatility that could result from FAS 133."

But Mr. Pieszko also suggested that the impact of the rule would be temporary.

"I would say [to fellow corporate-finance professionals] keep it simple. Clean out the more complex derivatives until the major issues get resolved and we see what the fair market value end product will look like... We've also started to see an influx from the investment banking community of new products that work under FAS 133....As that market matures, we'll have more hedging alternatives to consider."

Mr. Pieszko could not be reached to elucidate for this article. Bert Ely, a banking-industry correspondent, agreed that the effect is likely temporary.

"People will adjust to FAS 133," he said. "Also, [the Financial Accounting Standards Board] probably will tweak it at some point to smooth over its rough spots." The demand for derivatives products doesn't depend upon accounting rules, he said, in that "companies with significant interest-rate exposure need to be concerned about how the markets will react to insufficient hedging."

Other FASB News

Meanwhile, the FASB and its European counterpart, the International Accounting Standards Board, held a joint meeting at the FASB's headquarters in Norwalk, Conn., Sept. 18 to discuss the convergence of world accounting standards.

"The FASB and IASB are committed to working together in support of convergence in accounting standards that contribute to the health and vitality of our global capital markets," the two institutions said in a joint statement.

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