Financial Reporting - IASB - IASB must take a reality check

Commonsense is eluding the IASB over hedge accounting, argues Richard Raeburn.

The Association of Corporate Treasurers has been deeply involved in trying to influence the International Accounting Standards Board's approach to developing standards for derivative accounting. It has been a frustrating experience. We started with the clear conviction that fair value accounting is to be welcomed and that it should apply to risk management activities as broadly defined by the precedents of the US standards FAS 133 and 138.

We are frustrated because we have apparently been unable to focus the IASB on the practical consequences of its drafting. I say apparently because as I write there are just a few signs that at the 11th hour and 59th minute we may finally have succeeded in winning some acceptance that we have been making serious points to the IASB. We have not been alone in trying to achieve change: our fellow treasury associations in the rest of Europe have consistently made the same points to the IASB.

We want derivative accounting standards that embody the principles of fair value accounting but also - and this is of fundamental importance - recognise how business is conducted and what corporate risk management sets out to achieve. The most damning indictment of the drafting of

IAS 39, Financial Instruments: Recognition and Measurement, and its guidance notes is that it denies comprehensive hedge accounting treatment to actions that are prudently intended to minimise risk through hedging. This weakness in the standard arises where treasury management centralises currency risk within a group and neutralises those risks wherever possible, by putting together flows that can be treated as equal (in currency and timing) and opposite. The remaining net risk is laid off in the market and the internal matching is documented by contracts that provide individual subsidiaries with hedge cover for the risks they carry in their business.

Commonsense suggests that this practice of net hedging - which is economically efficient (it saves unnecessary market transactions) and reduces operational as well as financial risk - should benefit from hedge accounting, provided reasonable effectiveness tests are met. Our repeated attempts to highlight this with the IASB appeared to fail to win any acceptance that we had a valid concern. Only when we pointed out, at EU level and in yet further representations to the IASB, that one consequence of the current drafting will be recourse to special purpose entities (SPEs) and other off balance sheet vehicles did we begin to see any acceptance that there is a fundamental issue here.

We also want standard-setters who are qualified by virtue of their experience to direct the drafting of the IASB's work. The approach to

IAS 39 has highlighted the importance of such experience. Derivative accounting standards have a major impact on two different constituencies, the financial and the corporate sectors. The financial sector lobbied effectively and with substantial resources to seek more radical change than we had been asking for. The IASB seems to have listened and understood more readily than it was prepared to do for the corporate sector.

Danger of presumptions

I know from my own background as a partner at a Big Four professional firm the danger of presuming that an understanding of how banks manage risk qualifies an auditor to review the practice of corporate treasury risk management. The same danger applies to the IASB, in that we have sensed confusion as to the principles and objectives that determine how risk is managed by a corporate. Two consequences of this confusion - if

IAS 39 and its guidance notes remain unmodified - will be unnecessary and meaningless volatility in financial statements where hedge accounting treatment is denied, and a proliferation of SPEs as companies and banks create structures to allow current practice to be maintained and achieve hedge accounting. Neither of these outcomes reflects well on the cause of international standards.

•   Richard Raeburn is chief executive of the Association of Corporate Treasurers.

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