AFP Blogs

FASB’s Chairmen, Bob Hertz, gave a podcast to discuss the exposure draft on Accounting for Financial Instruments (Formerly issued as FAS 133).  Hertz indicated in the podcast that there are basically three elements addressed in the proposal:

1. Classification and measurement – Whether an instrument will be carried at fair value versus amortized costs and whether the changes in fair value will be recorded in earnings or other comprehensive income (OCI).  the proposed change would require those instruments held to maturity be continue to be recorded at amortized costs but now also report their respective fair values through OCI.
2. Impairment of loans and debt securities – Proposed changes attempt to simplify current methodology by requiring just one model for all of these instruments.  Currently there are various models for accounting for loan impairment (e.g. as currently found in FAS 5 – measuring collective impairment, FAS 114 – measuring individual impairment, SOP 03-3 – measuring impairment of purchased loans to name a few)
3. Hedging of financial instruments and risks using derivative instruments. – Proposes a more simplified model for hedging as the current hedge model has been deemed to be onerous and overly complex.

Hertz indicated that the rewrite will hopefully improve the overall relevance and usefulness of information provided to investors and other users of the information. 

Hertz also indicated that companies with a significant treasury operation would more than likely be impacted by the changes (e.g. some manufacturing companies). 

In addition, companies that have a significant debt portfolio and retail companies that extend loans out to their customers will also be impacted.  

Hertz’s podcast can be viewed at the FASB’s website.

The Financial Accounting Standards Board (FASB) has issued an Exposure Draft (ED) of a proposed Accounting Standards Update (ASU) intended to improve accounting for financial instruments. This is a replacement for the existing standard FAS 133.  Among other changes, the proposed ASU would seek to bring more transparency into financial statements by incorporating both amortized cost and fair value information about financial instruments held for collection or payment of cash flows.

The proposal also aims at providing more timely information on anticipated credit losses to financial statement users by removing the “probable” threshold for recognizing credit losses. It seeks to better portray the results of asset-liability management activities at financial institutions. In the proposal, non-public entities with less than $1 billion in total consolidated assets would be allowed a four year deferral beyond the effective date from certain requirements relating to loans and core deposits.

Other potential improvements addressed by the ASU include:

1. A single credit impairment model for both loans and debt securities.
2. The criteria for hedge accounting would be simplified in order to improve the consistency in the reporting of the economic impacts of hedging activities.

The comment period for the proposed ASU extends through September 30, 2010. The FASB will also hold additional public roundtable meetings immediately following in October to collect further input. In addtion, the FASB will be hosting a live webcast on the financial instruments proposal on June 30, 2010. The proposal is available at www.fasb.org.

AFP is carefully examining the ED to determine whether we will issue a comment letter. More detailed analysis of the changes are to follow. We are planning to host a webinar that will inform our members of the proposed changes in this model and the impact it will have on their operations.

The Securities and Exchange Commission (SEC) proposed a new rule that would require the self-regulatory organizations (SROs) to establish a consolidated audit trail system that would enable regulators to track information related to trading orders received and executed across the securities markets. The SEC believes that a consolidated audit trail system would help regulators keep pace with new technology and trading patterns in the markets.

Currently, there is no single database of comprehensive and readily accessible data regarding orders and executions. Stock market regulators tracking suspicious market activity or reconstructing an unusual event must obtain and merge an immense volume of disparate data from a number of different markets and market participants. Regulators are seeking more efficient access to data through a far more robust and effective cross-market order and execution tracking system.  Hopefully this will expand regulatory monitoring  and oversight activities.  In addition promote more market discipline amonst the SROs.

The Securities and Exchange Commision (SEC) voted to approve rule changes that improve the qualifty and timeliness of municipal securities disclosure. Municipal securities, such as municipal bonds, are exempt from the disclosure requirements of the federal securities laws. However, the SEC adopted Rule 15c2-12 in 1989, which was designed to foster greater transparency in the municipal securities market, by regulating those who underwrite, or sell, municipal securities. Today the SEC passed an amendment to Rule 15c-12.  The amended rule:

1. is expanded to apply to new issuances of VRDO securities.VRDOs bear interest at a rate that is reset periodically and investors are able to sell them back to the issuer at certain times for their full value.
2. improves disclosure of tax risk. The amended rule will specifically include disclosure of events that may adversely affect a bond’s tax exemption, including issuance by the IRS of proposed and final decisions about whether the bond can be taxed.
3. strengthens and expands disclosure of important events. The amended rule increases the number of events deemed important that should be disclosed to include: (1) tender offers; (2) bankruptcy, insolvency, receivership or similar proceeding; (3) mergers, consolidations, acquisitions, the sale of all or substantially all of the assets of the obligated person or their termination, if material; and (4) appointment of a successor or additional trustee or the change of the name of a trustee, if material. Under the existing rule, an underwriter must have a reasonable belief that the state or local government that issued municipal bonds has agreed to provide ongoing, continuing disclosure of certain important events.
4. establishes a more specific filing deadline. The amended rule will provide that notices of the events listed in the rule be disclosed in a timely manner not more than 10 business days after the event. Currently, the rule simply provides for disclosure ‘in a timely manner.’
5. provides additional guidance. The amended release reaffirms that, to have a reasonable basis to recommend a security, a municipal underwriter must carefully evaluate the likelihood that a municipality will make the ongoing disclosure called for by the amended rule. The adopting release further states that it is doubtful that an underwriter could form a reasonable basis to recommend a security if the municipality had a history of persistent and material non-disclosure.

It’s Friday, and I wish I could end one of these weeks on a happier note, but unfortunately we are not living through such blissful times. Concerns about the financial situation in Europe continue to be the focus of the world’s markets. We received plenty of signs this week that investors around the globe are very concerned about the long and short-term impacts of Europe’s economic malaise.

The buzzwords of the week were definitely “volatility and flight-to-quality”. Stock markets around the world continued on their recent descent. Approximately $5.3 trillion of market value has been wiped out so far during May. A day that the Dow Jones Industrials doesn’t move either up or down at least 100 points, seems like a quiet day.

We witnessed a tremendous amount of buying of relatively safe U.S. Treasury securities. The yield on the U.S. 10-year dropped to a current-year low of 3.20%. We haven’t seen the yield this low since early December 2009. The current rally in U.S. Treasuries is the strongest in 14 months, and remember, 14 months ago was March 2009, when the world was pretty much at the apex point of the financial crisis.

Another sign of the flight-to-quality trade has been foreign exchange rates. The Euro fell to a 4-year low versus the US dollar this week, touching $1.2122. It is interesting to note that the euro has actually averaged around $1.18 since its introduction in 1999, not very different than its initial rate. I personally was surprised to see the average rate so low. I would have guessed it to be in the $1.35 range. One must remember that over the first 5 years of the euro’s existence it never traded above $1.20. It has only been since 2006, that the euro has been consistently rich to the US dollar. I suppose as a group we can be accused of being guilty of myopia. (In my case, being myopic and the fact I’m still scarred from my trip to Europe in April 2008 when the euro was trading around its all-time high of $1.59). The British pound also fell to a 13 month low against the US dollar, touching $1.4231. (Don’t get me started on my trip to England in August 2008 with the pound trading around $2.00).

3-month LIBOR increased for the 12^th straight week. The rate is now at a 10 month high of 49.7bps. There is a growing fear that the increasing LIBOR rate is a function of an unwillingness of banks to lend to one another. In the US and Europe there are no serious concerns that either the Fed or the ECB is going to raise interest rate in the next 3 months. The LIBOR-OIS spread is now at its widest since August 2009.

Here in the U.S., the Senate passed its version of the Financial Reform bill. The vote was 59-39 and it was interesting who voted for and against the bill. Four Republicans broke party ranks and voted in favor of the bill. Brown of Massachusetts, Grassley of Iowa, and Collins and Snowe of Maine joined 55 Democrats in voting “yea” for the bill. Two Democrats voted against the bill, Feingold of Wisconsin and Cantwell of Washington; they felt the bill wasn’t strong enough. Byrd of West Virginia and Specter of Pennsylvania did not vote on the bill.

The bill will now have to be reconciled with the House version that was passed back in December. The expectation is that a bill will be crafted and presented to the President prior to the Fourth of July holiday.

Let the horse trading and games begin!

Will a trillion dollars be enough to save Europe from Europe? After finding out that neither a $60 billion nor a $160 billion package was not going to be sufficient support to provide a backstop to the continuing soap opera that is the EU, this week the powers that be upped the ante and introduced their $1 trillion solution.

Given the market’s reaction on Monday, it appeared that the EU had bought some time to come up with a credible plan to put the balance sheets of many European countries in the order they so desperately need. Unfortunately by Tuesday the fears of the past few months showed themselves. The euro gave up all its previous gains from the bailout announcement and continued on its recent decline. As of Friday, the euro touched an 18-month low of $1.2359. The major concern being was that maybe needing a $1 trillion support package wasn’t a “good thing”.

As the week progressed (or digressed depending on your point of view) the market continued to show its lack of faith in the rescue package. On the positive side, the big Trillion did remove a significant amount of tail risk. The probability that one of the PIGS would default on their sovereign debt decreased significantly from last week. CDS spreads and yield premiums confirmed this as the levels dropped from their historical highs.

On the negative side, we witnessed an increased risk premium associated with banks that have a real or perceived exposure to Europe. CDS and yield premiums for banks increased as the week progressed. 3-month LIBOR increased as we got later and later into the week. The rate now stands at 44.5 bps, the highest level since August 2009.

Part of the reason for the recent increase in the LIBOR rate may be due to an unwillingness of banks to lend to one other. This would be a similar situation to the inter-bank market after the Lehman bankruptcy. Banks are fearful to lend to other banks because they are unsure about the degree of exposure their counterparties may have to Europe. 

With concerns that the global economy may be growing at a slower pace than previously thought, a number of commodities saw their prices drop this week. Crude oil touched $71.63, the lowest level since February. The price for copper, aluminum, and zinc all dropped during this week.

Gold was somewhat the exception in the commodities world. On Friday gold touched a new all-time high of $1249.70/oz. Given all the uncertainly we have experienced of late; gold has been a beneficiary of a flight to safety.

In other news, the UK welcomed their first coalition government since World War II. This was the first time since 1974 that elections in the UK failed to produce a majority government. As the saying goes, “Politics makes for strange bedfellows”. The joining of the Conservatives with the far-left Liberal Democrats (or Lib Dems as they are known) has many wondering how long this government will last.

As the Senate nears a vote on financial regulatory reform, possibly later this week, Commodity Futures Trading Commission Chairman Gary Gensler touted over-the-counter derivatives reform at AFP’s Global Corporate Treasurers Forum today in Washington, DC.

Speaking before an audience of AFP members, Gensler said OTC derivatives reform must be:
• Comprehensive, regulating all financial firms that handle derivatives
• Standardized, offering exchanges to improve transparency and price, and
• Centralized, using clearinghouses so the CFTC can track trades.

“The more transparent it is, the more liquid and more competitive it is for our business, and it will ultimately improve your costs,” Gensler said.

Gensler added that end-users could choose not to trade derivatives with standardized contracts through clearinghouses—a major sticking point with some. “This would benefit all the corporates the Association for Financial Professionals represents,” he said.

In a question-and-answer period with AFP members following his remarks, Gensler said that the CFTC is working with its regulatory counterparts in Europe to create uniform derivatives regulations. One AFP member wondered whether trading derivatives with standardized contracts through clearinghouses would impact his ability to use hedge accounting. Gensler answered that he could use hedge accounting because the trade could be a “tailored transaction,” which would qualify for FAS 133.

Asked whether it was difficult to make the case for derivatives reform to Wall Street, Gensler was curt. “They get to make their case to Congress, and we get to make our case to Congress.”

The IASB published today an exposure draft on how to account for the fair value changes of liabilities due changes in an entity’s own credit.  In summary, the IASB has tentatively decided that when an entity elects the fair value option, and marks to market its liabilities, the changes associated with their own credit would not flow through the income statement as a gain or loss.  Rather, those changes would be reported through OCI. All other noncredit related changes would continue to flow through the P&L.?

As you may recall AFP has been very vocal to the IASB and to FASB on this issue. AFP’s Financial Accounting and Investor Relations (FAIR) Committee issued comments letters to both bodies stating our objection with credit changes flowing through the P&L. In making this decision, the IASB now acknowledges that “volatility in profit or loss resulting from changes in the credit risk of liabilities that an entity chooses to measure at fair value is counter-intuitive and does not provide useful information to investors.”

This seems to be a positive step the IASB has made and demonstrates that they are listening and attempting to address our members concerns.?

Money market funds (MMFs) have undergone major guidelines changes to improve their liquidity, safety, credit quality and transparency. The SEC instituted new rules about:

• Maturities of securities in a fund
• Types of securities in a fund
• Amount of liquidity in a fund
• How the holdings of the fund and the market value of those securities should be reported to the public.

Money fund resources for financial professionals can be found at www.afponline.org/moneyfunds.

A complimentary webinar on MMFs changes will be held May 19, at 3:30 pm ET. Register here.

The Public Company Accounting Oversight Board is soliciting nominations for its Standing Advisory Group (SAG). The PCAOB solicits nominations annually and is currently seeking to fill appointments for the two-year term of 2011-2012. Nominations, including self-nominations, may be submitted by any person or organization. The nomination forms are available online. The deadline for submissions is June 17, 2010.  Please let me know if you have an interest to serve.

The SAG currently has 30 members with expertise in a wide variety of fields, including accounting, auditing, corporate finance, corporate governance, and investing in public companies. The PCAOB seeks nominations for members who can provide diverse perspectives on the PCAOB standard-setting activities.

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