Chatham Financial Comments on FASB’s Proposal on Financial Instruments and Hedge Accounting

September 29, 2010

We recently provided our views to the FASB on its controversial proposal to modify the accounting for financial instruments, including revisions to the accounting for derivatives and hedging activities. With respect to financial instruments in general, we continue to believe that both fair value and amortized cost have merit, and we share the concerns of most constituents that the FASB proposal goes too far with fair value as the primary measurement attribute for nearly all financial instruments.

As for derivatives and hedging, we agree with certain provisions of the proposal, including reducing the standard for hedge qualification from “highly effective” to “reasonably effective.” However, we have serious concerns about the FASB’s proposed prohibition against removing the designation of an effective hedge (no more de-designations) and the substantial transaction costs that would be incurred by companies to “fully offset” such positions in the marketplace to achieve an “effective termination” under the new rules.

We also think the FASB is missing a golden opportunity to significantly simplify/improve the hedge accounting model and further converge with IFRS. In particular, we would like to see the FASB permit companies to hedge any “separately identifiable and reliably measurable” portion or component of a financial instrument’s cash flow or fair value (for example, permit non-benchmark-rate indices like Prime and Fed Funds to be treated similarly to a benchmark rate like LIBOR). Without going into detail, this provision also would significantly simplify the accounting for fair value hedges of fixed-rate assets and liabilities–and even provide a reasonable approach for hedges of callable debt. We also would like to see the FASB permit bifurcation-by-risk for identifiable and measurable components of nonfinancial items.

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