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FASB releases enhanced guidance on Fair Value Hedging activities – Portfolio Layer Method

Date:
March 29, 2022
  • eri panoti headshot

    Authors

    Eri Panoti

    Director
    Accounting Advisory

    Financial Institutions | Kennett Square, PA

On March 28, 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. This new guidance further aligns risk management objectives with hedge accounting results on the application of the last-of-layer method, which was first introduced in Accounting Standards Update No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The enhanced guidance further improves the last-of-layer concepts to expand to nonprepayable financial assets and allows more flexibility in the derivative structures used to hedge the interest rate risk. For entities that have already adopted ASU 2017-12 this update is available for immediate adoption. Most of the provisions in this update have prospective application with the exception of the basis adjustments changes which would have a modified retrospective application.

Highlights related to portfolio construction and maintenance:

  • All financial assets are permitted to be included in a fair value hedge of a portfolio layer method regardless of contractual prepayment features.
  • Contractual maturity requirements have been removed, but they do influence layering abilities and basis adjustment recognition upon breach of any hedged layers.
  • A one-time transfer of securities from held-to-maturity to available-for-sale is permitted, if they are included in a portfolio layer method hedge within 30 days of transfer.
  • Anticipated and actual breach events have an aligned application. Partial or full dedesignations are required for any anticipated or actual breaches in the closed portfolio.
  • When a breach is either anticipated or has occurred, an accounting policy is to be developed that will determine the dedesignation method prospectively.

Highlights related to hedging strategies:

  • Multiple layer hedging is permitted within the same closed portfolio. Horizontal and vertical stacking of different hedged layers are permitted within the same closed portfolio.
  • Different derivative structures are permitted including spot-starting and forward-starting bullet-notional swaps as well as amortizing-notional swaps.
  • Voluntary full or partial dedesignations/terminations are permitted anytime when a breach is not anticipated nor has occurred.
  • The income statement effect of any breach in the closed portfolio must be reported in interest income.

Changes to accounting for basis adjustments

The FASB clarified that basis adjustments will be prohibited from being allocated to the individual assets while the hedging relationships are active but must be allocated to the appropriate balance sheet line items if more than one asset class is included in portfolio hedges. This may create an operational burden for those institutions that were previously allocating basis adjustments at the individual asset level and will require a transition adjustment which is required to be reported through retained earnings upon adoption of the guidance. Furthermore, the FASB confirmed that basis adjustments are prohibited from being included in the credit loss calculation throughout the updated guidance.

In conclusion

Chatham Financial has followed this project very closely over the years and has had a significant role in working with the FASB to help shape the new guidance. Please subscribe to our upcoming updates and webinars for more in-depth discussions on specific strategies and the impact of hedge accounting changes.

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Contact us

We are happy to answer your questions and help you understand the potential impact the new guidance may have on your hedging program.

About the author

  • Eri Panoti

    Director
    Accounting Advisory

    Financial Institutions | Kennett Square, PA

    Eri Panoti leads the Financial Institutions Hedge Accounting practice and advises clients on hedge accounting policy and application for both balance sheet risk management strategies as well as customer hedging needs.

Disclaimers

Chatham Hedging Advisors, LLC (CHA) is a subsidiary of Chatham Financial Corp. and provides hedge advisory, accounting and execution services related to swap transactions in the United States. CHA is registered with the Commodity Futures Trading Commission (CFTC) as a commodity trading advisor and is a member of the National Futures Association (NFA); however, neither the CFTC nor the NFA have passed upon the merits of participating in any advisory services offered by CHA. For further information, please visit chathamfinancial.com/legal-notices.

Transactions in over-the-counter derivatives (or “swaps”) have significant risks, including, but not limited to, substantial risk of loss. You should consult your own business, legal, tax and accounting advisers with respect to proposed swap transaction and you should refrain from entering into any swap transaction unless you have fully understood the terms and risks of the transaction, including the extent of your potential risk of loss. This material has been prepared by a sales or trading employee or agent of Chatham Hedging Advisors and could be deemed a solicitation for entering into a derivatives transaction. This material is not a research report prepared by Chatham Hedging Advisors. If you are not an experienced user of the derivatives markets, capable of making independent trading decisions, then you should not rely solely on this communication in making trading decisions. All rights reserved.

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