Project Pages

Derivatives

Primary Objective: The objective of this project is to consider whether derivatives should be displayed at fair value on the statement of net assets and whether current derivative note disclosures are appropriate. If derivatives are recognized in the financial statements, consideration of hedge accounting will be necessary. Disclosures, such as derivative objectives, terms, and risks, also will be included within the scope of deliberations.

Status: The Board reviewed the ballot draft of the Statement on Accounting and Financial Reporting for Derivative Instruments at the June 2008 teleconference. The Board approved the release of the Statement.

Derivatives and Hedging—Project Plan

Project Description: The objective of this project is to consider whether derivatives should be displayed at fair value on the statement of net assets and whether current derivative note disclosures are appropriate. If derivatives are recognized in the financial statements, consideration of hedge accounting will be necessary. Disclosures, such as derivative objectives, terms, and risks, will also be included within the scope of deliberations. Because of the state of existing standards for state and local governments, a Statement is expected to be followed by an Implementation Guide.

Background: This project is needed to establish additional financial reporting or disclosure requirements for derivatives and hedging accounting that will assist financial statement readers in making decisions and assessing accountability. When the Board issued Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, in 1997, a number of financial instrument issues were not addressed. For example, derivatives, hedge accounting, and fair values of liabilities were not included in the scope of the Statement. Statement 31’s background information indicates that it was the first phase of the Board’s Financial Instruments project, thereby establishing an expectation that the Board would address the remaining issues in a follow-up project(s).1

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1Statement 31, paragraphs 26 and 41.

Current accounting requirements call for extensive derivative disclosures. There is no specific requirement to present a derivative’s fair value on the face of the financial statements (except for pension and OPEB plans). Likewise, the Board has not addressed hedge accounting in this area. This is a significant issue because fair value gains and losses can relate to another asset, liability, or anticipated transaction.

Accounting and Reporting Issues

The following major issues have been identified. The list provides a basic outline of how the project is scheduled progress.

  1. Should the GASB develop a new definition for derivatives? If so, how? The definition in Technical Bulletin No. 2003-1, Disclosure Requirements for Derivatives Not Presented at Fair Value on the Statement of Net Assets, is consistent with the definition in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities.
  2. Are there derivatives that should not be included in the scope of the standard, such as derivatives associated with normal purchases and sales? Firm commitments? Anticipated transactions? Insurance contracts? How should embedded derivatives be treated?
  3. Should the fair value of derivatives be disclosed in the notes or displayed in the financial statements? In other words, are derivatives commitments that should be disclosed? Or are they assets and liabilities that should be displayed on the statement of net assets?
  4. If derivatives are displayed, should hedge accounting be permitted? Is the hedged item also displayed at fair value? Or should the hedge and the hedged item be reported using some other method?
  5. What are the parameters of hedge accounting (if permitted)? Should there be a hedge effectiveness test to qualify for hedge accounting? If so, what is the frequency of such tests?
  6. If hedge accounting is used, should there be a "shortcut" method? That is, a method in limited circumstances that avoids hedge effectiveness tests and documentation requirements.
  7. Should future contracts be included in the scope of the project? FASB Statement No. 80, Accounting for Futures Contracts, provides the current GAAP for government. Should the requirements for derivatives parallel the requirements for future contracts?
  8. Should matched-book financings be permitted hedge accounting?
  9. What derivative and hedging information should be disclosed? Should the requirements of TB 2003-1 be updated and incorporated into a Statement?

Project History

Technical Bulletin No. 2003-1, Disclosure Requirements for Derivatives Not Presented at Fair Value on the Statement of Net Assets, was issued June 2003. The Bulletin provides interim guidance pending the completion of the Derivatives and Hedging project.

A meeting of the Derivatives and Hedging task force was held in April 2003. Scope and accounting issues were discussed. At its July 2003 meeting, the Board discussed whether derivatives should be reported at fair value on the statement of net assets. Cash flow hedge accounting methods were the focus of discussions for 2003 Board meetings.

At the December 2003 and January 2004 meetings, the Board participated in educational sessions with selected members of the Derivatives and Hedging task force. The Board began considering a context-based method of measuring derivatives as a potential alternative to other forms of fair value reporting. The context-based method would measure a derivative based on the measurement attribute used for a clearly and closely related asset or liability.

At the March 2004 meeting, the Board tentatively concluded that derivatives represent assets and liabilities, and should be reported as such on the balance sheet. At the April 2004 meeting, discussion centered on swaptions and the application of the context-based method. The Board tentatively decided that under the context-based approach, the intrinsic value of the issued option represents a borrowing. If the option expires worthless, the Board tentatively decided that a gain should be recognized at expiration.

At the May 2004 meeting, discussion of swaptions and the context-based method continued. The following tentative decisions were reached relative to the potential use of a context-based method. In governmental funds, swaption payments for intrinsic value generally should be reported as a long-term liability. A governmental fund should measure an option for time value using fair value. Within the context-based method and during the option period, the swaption should be measured using fair value. The Board also discussed derivatives used in the purchases and sales of commodities—futures contracts, forward contracts, and commodity swaps—in the development of the context-based approach. The Board tentatively concluded that forward contracts and commodity swaps for normal purchases and sales should be excluded from this project. Within the context-based method, commodity derivatives (those not tentatively excluded) associated with anticipated transactions and firm commitments should be measured at fair value with increases and decreases reported as gains and losses.

At the July 2004 meeting, the Board considered how the context-based method should treat the possibility of a derivative’s early termination. The Board tentatively specified that certain "indicators" suggest that the derivative should be reported at fair value immediately, whereas other indicators suggest that the derivative needs to be reassessed to determine the likelihood of early termination.

At the August 2004 meeting, the Board considered but did not make a decision regarding a hedge accounting method. Three alternatives were considered: mark-to-market, deferral, and basis adjustment. The Board discussed, but agreed not to pursue macro hedging. The Board deferred a decision on recognizing hedge ineffectiveness.

At the October 2004 meeting, a swap advisor led a discussion on (1) how derivative fair values are estimated, (2) current developments in the municipal swap market, and (3) hedge effectiveness. No decisions were made.

At the November 2004 meeting, the Board tentatively agreed to recognize hedge ineffectiveness as gain or loss and to use the deferral hedge accounting method.

At the January 2005 meeting, the Board discussed a comprehensive hedge accounting illustration. This illustration included the process of constructing and analyzing a three-year swap. Issues of ineffectiveness, over- and underhedging, and recapture were also discussed. No decisions were made at this meeting.

At the February 2005 meeting, the staff briefed the Board on the results of their interviews with a limited number of financial statement users regarding reporting ineffectiveness as gains and losses, and potential hedge criteria. The Board then discussed the two papers presented by the staff. The first paper followed up the January meeting discussion of reporting ineffectiveness by providing additional reporting examples, including recapture. The second paper presented a first draft of a staff proposal for identifying derivatives that would qualify for either the context-based approach or hedge accounting. The Board’s discussion focused more on the objective of the project than on the qualifying conditions and criteria presented in the paper; therefore, no decisions were reached on the staff proposal. The Board then discussed the general direction of the project. For the April meeting, the project team presented a review of the scope of the project, tentative decisions already made, the issues identified to date with regard to the two basic alternatives under consideration (context-based method and hedge accounting), and a detailed project plan for addressing remaining issues.

At the April 2005 meeting, the Board considered a revised project plan that significantly revised topics to be considered in the work plan and publication dates. Added to the work plan was issuance of a Preliminary Views document. Scope issues were also evaluated: The matched book issue was removed and the Board affirmed that derivatives disclosures should continue to be within the scope of the project. The Board tentatively rejected a historical cost-based approach to the measurement of derivatives.

At the May 2005 meeting, the Board considered the comprehensive accounting method for the reporting of derivatives. Fair value without special accounting, fair value with hedge accounting, and the context-based method were considered. The Board tentatively decided to report derivatives using the fair value with hedge accounting method.

At the June 2005 meeting, the Board focused their formal discussion on two topics. The first was a discussion of what is hedgeable. The Board tentatively decided that firm commitments and forecasted transactions are items that may be hedged, provided they meet the criteria (to be developed) for hedge accounting. The Board also tentatively decided that transactions solely within a government—interfund transactions—may not be hedged. However, transactions between a primary government and a discretely presented component unit would be hedgeable. Risks associated with only a portion of cash flows or fair values of a financial asset or liability (or potential financial asset or liability) would be hedgeable, provided that effectiveness could be measured. Further research will be conducted on comparable treatment of risks associated with nonfinancial assets and liabilities. Groups of similar assets, liabilities, firm commitments and forecasted transactions would be hedgeable. The Board also agreed that further research was needed on whether or not to allow hedges of a net position and foreign currency risk. The second paper focused on the termination of hedge accounting in circumstances other than when the expected payments have been made or a derivative’s term has expired. The Board tentatively decided that in all cases, the balance in the deferral account would immediately be recognized as gain or loss on the change statement.

At the August 2005 meeting, a representative from the Southern Nevada Water Authority (SNWA) led an educational discussion on commodity swaps. He described the objective of SNWA’s hedging program and outlined the various methods for assessing its effectiveness. He detailed the differences between cash settlement of a commodity hedge compared to physical delivery. He also described the various layers of swaps his authority uses to eliminate price risk. No decisions were made.

At the November 2005 meeting, a panel of financial statement users discussed issues related to derivatives, disclosures, hedges, and ineffectiveness. The panel presented ideas about what an effective hedge should be and the type of information related to derivatives that they would find most useful in their analysis. With regard to ineffectiveness, the panel discussed various methods of presentation and potential methods of calculation. After the panel discussion, the Board discussed the project plan and contemplated the issues presented in the staff paper. The Board determined that it needed additional time to consider the recommendations of the panel. Therefore, the issues were presented again at the November teleconference along with a revised Preliminary Views document.

At the November 2005 teleconference, the Board discussed the criteria needed for a hedge to qualify for hedge accounting. The Board also discussed when a hedge is no longer effective for hedge accounting purposes. The Board tentatively decided that staff should continue research on critical values. That research may be helpful in determining when hedges qualify for hedge accounting and when hedges are no longer effective. This research was not scheduled in the technical plan and may delay the project by one Board meeting. The Board also discussed the issue of ineffectiveness. The Board tentatively decided that the ineffective portion of an effective hedge should be disclosed.

At the December 2005 meeting, the Board determined that hedge accounting is a requirement and not an option and continued the discussion of potential criteria for a derivative to be reported as a qualifying hedge. Staff’s research on illustrations was also presented.

At the January 2006 teleconference, the Board tentatively decided that critical values for determining hedge effectiveness are requirements, not guidelines. The Board discussed when hedging gains and losses should be reported. The Board tentatively decided that the previous decision to recognize hedging gains and losses at the time of the early termination still stands. Hedging illustrations were also discussed. The Board considered the issue of a synthetic fixed interest rate. Specifically, the Board questioned whether this rate should equal the fixed rate on the swap or if the projected receipts on the swap and payments to the bondholders also need to be considered. Additionally, the Board discussed the potential for early termination of a hedge and the possibility of a large cash payment.

At the January 2006 Board meeting, the Board reviewed draft language that would be included in a Preliminary Views document. The Board indicated general support for the content of the document and suggested specific edits. The Board discussed whether the definition of derivatives contained in FASB Statement 133 should be incorporated in its entirety or by reference. The Board tentatively decided to incorporate the Statement as its own, stipulating that modifications would be necessary to address certain unique requirements of the state and local government environment. The Board’s discussion of off-market swaps yielded a tentative consensus that derivatives carrying up-front payments to the government should be reported as a hybrid instrument. The up-front payment is a borrowing that the government has committed to simultaneously upon entering into an at-the-money swap. As a loan, the liability associated with the up-front payment would be reported at its historical price.

At the February 2006 teleconference, The Board studied draft language of the Preliminary Views (PV) document, which had been updated to reflect the Board’s discussion at the February 2006 Board meeting. The Board indicated general support of the staff’s recommendation requiring a 90/111 range for the effectiveness test for synthetic instruments. The Board also determined that hedge effectiveness could be assessed at two levels: first on an annual basis; second on a life-to-date basis. If the hedge is shown to be ineffective on an annual basis, it may still qualify for hedge accounting if it is shown to be effective on a life-to-date basis.

At the March 2006 Board meeting, the Board studied draft language of a Preliminary Views document. A chapter on disclosures was presented. In that discussion the Board tentatively agreed to extend disclosures required by TB 2003-1 to all derivatives.

At the April 4, 2006 teleconference, the Board reviewed a preballot draft of a Preliminary Views and Plain Language documents. At the April 2006 Board meeting the Board approved publication of the Preliminary Views document and reviewed a Plain Language Supplement before its release. The Preliminary Views document incorporated the Board’s tentative decisions on major aspects of the project at the time it was issued.

On June 21, 2006, a public hearing was held in San Diego, California. Seventeen individuals representing twelve organizations participated. On July 10, 2006, a public hearing, panel, and user roundtable was held in New York City. Twenty-two individuals representing 21 organizations participated. Ninety-one comment letters were received, including 14 letters that specifically addressed the stable value issue.

At the July 2006 Board meeting, information on guaranteed investment contracts (GICs) and synthetic GICs was provided by representatives of the Stable Value Investment Association. No decisions were made.

At the August 2006 Board meeting, staff papers on stable value investments and staff’s general reaction to due process comments were presented. A revised technical plan was also presented.

At the October 2006 Board meeting, the Board tentatively decided that as a general requirement, derivatives covered in the scope of this project should be reported at fair value in a government’s balance sheet. Derivative fair value changes will be reported in a government’s change statements as part of investment income, unless the derivative is an effective hedge. Likewise, derivatives reported in governmental funds should be measured at fair value.

At the October 2006 Board meeting, derivatives that contain a financing element in the form of an up-front payment are hybrid instruments were considered. The Board tentatively decided that such an instrument should be bifurcated into its component pieces. An up-front payment that a government receives should be reported as a liability.

At the November 2006 teleconference, the Board tentatively decided that synthetic guaranteed investment contracts should be measured at contract value, provided that they are benefit responsive.

At the November-December 2006 Board meeting, the Board tentatively decided that up-front payments received in government funds should be reported as other financing sources. The Board tentatively concluded that up-front payments are essentially borrowings and should be treated as such in both the government-wide and governmental fund financial statements. The Board also considered several hedging issues. The Board tentatively decided that hedge accounting should be a requirement for both the government-wide and governmental fund financial statements. Further, the Board tentatively decided that hedge accounting should result in deferrals of the fair value changes of derivatives on the balance sheet. The Board tentatively decided that management’s intention to establish a hedge is not a requirement for a derivative to be classified as a hedge and that the analysis used for tax purposes (in order to avoid the arbitrage tax) is not sufficient evidence that a hedging relationship is effective. The Board tentatively decided that cost/savings analysis is not a sufficient form of effectiveness testing because the primary purpose of hedging is to mitigate risk.

At the December 18, 2006, teleconference the Board tentatively agreed to accept Securities Industry and Financial Markets Association swap index as a proxy for interest rate risk. The Board tentatively agreed that it would be helpful to provide examples of some typical risks that are hedged using derivatives, but it did not feel it was necessary to limit the types of risks that were able to be hedged so long as they are measurable. The Board also clarified that foreign currency risk was a hedgeable item. The Board tentatively agreed that in funds reporting as a business type activity, the hedging derivative should be reported in the same fund as the hedged item.

At the January 2007 meeting, the Board tentatively decided that settlement payments arising from interest rate locks should be reported as other financing sources or uses in governmental funds. The Board also tentatively decided that in governmental fund statements, hedging derivatives associated with hedges of expected transactions should be reported in the fund that will report the hedged transaction. Under the synthetic instrument method, the Board tentatively decided that the critical values for this method should be presented as requirements. Next, the Board tentatively agreed with the staff that the method should be limited to hedges of changes in overall cash flows. Finally, the Board tentatively decided that the range of the critical values of the method will remain between 90 to 111 percent.

At the January 29, 2007 teleconference, the Board continued its discussion about the use of quantitative methods in assessing hedge effectiveness. The Board tentatively agreed that regression should continue to be used as a way in which to assess hedge effectiveness. The Board tentatively affirmed that dollar offset is a valid manner in which to assess hedge effectiveness. The Board tentatively agreed that the PV’s hybrid instrument treatment is consistent with the notion that the accounting standard would be requiring derivatives to be measured and reported at fair value. The Board tentatively agreed that a scope exception for certain financial guarantee arrangements similar to that in paragraph 10(d) of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, should be incorporated into the proposed derivatives standard.

At the February 2007 Board meeting the Board tentatively decided that expected transactions would be split into two groups, those that possess a contractual/commitment type component and those that do not. The Board tentatively agreed that only those expected items with a contractual/commitment-type component will be eligible for effectiveness testing using either the consistent critical terms (CCT) method or the synthetic instrument method. Furthermore, the Board tentatively decided that language should be added to the Exposure Draft that requires effectiveness monitoring on an ongoing basis throughout the hedge period when applying the CCT method to expected transactions. The Board tentatively agreed with staff that option-based hedges should be evaluated for effectiveness according to the objectives of the hedges. The Board tentatively decided that governments will be required to test all the methods available to them at the inception of a hedging relationship before the government could determine that a hedging relationship is ineffective. A government will be required to test all available methods (even methods that the relationship had failed in prior periods) before a hedge can be classified as ineffective. The Board tentatively agreed that once a hedge has been determined to be ineffective, that relationship cannot be determined to be effective later in the future. Then the Board tentatively decided that at the point that a hedging relationship is determined to be ineffective, the entire deferral account would be recognized in the change statement.

At the March 12, 2007, teleconference the Board tentatively decided that detailed hedge-based information should not be a required disclosure. The Board tentatively agreed that disclosures surrounding collateral posting requirements and triggers should be required disclosures. The Board, however, did not believe that a sensitivity analysis disclosure should be required. The Board tentatively agreed that required disclosures should include disclosure of the net exposure to credit risk and the aggregate amounts by which netting arrangements and counterparty collateral or other security reduce a government’s gross exposure to credit risk. The Board also tentatively decided that a concentration of credit risk disclosure should be required. This disclosure would be based on the percentage of net exposure to credit risk associated with derivatives with an individual counterparty. The Board did not believe that a specific threshold percentage should be provided in the requirement as to when a concentration should be disclosed. The Board believed that this disclosure should be required for "significant concentrations" of derivatives with individual counterparties. Lastly, the Board tentatively decided that a government should be required to disclose its policies related to counterparty collateral requirements and netting arrangements.

At the April 2007 meeting, the Board tentatively deciding to accept the staff’s revised version of the "derivative summary table" disclosure as opposed to the version previously included in the Preliminary Views (PV). Next, the Board tentatively agreed with the staff recommendation that for investment derivatives, detailed derivative terms and individual fair values should not be a required disclosure; however, for hedging derivatives, the detailed derivative term disclosure requirements of Technical Bulletin (TB) No. 2003-1, Disclosure Requirements for Derivatives Not Reported at Fair Value on the Statement of Net Assets, should be continued. The Board also agreed with the staff’s recommendation that for noninvestment derivatives, the detailed derivative term disclosures requirements of the TB should be continued.  The Board considered alternative approaches to presenting derivative disclosures—allow governments to refer to separately issued financial statements of discretely presented component units, as required supplementary information, and a method similar to one used in Statement No. 40, Deposit and Investment Risk Disclosures. The Board tentatively decided that there should be no change from the current requirement. The next set of issues dealt with hedges of expected transactions. The Board agreed with the staff recommendation that an expected transaction can be a hedgeable item. Furthermore, the Board agreed with the staff’s depiction of how the various hedge effectiveness methods would be applied to hedges of expected transactions. The Board agreed with the staff recommendation that the transition guidance in the PV be carried forward to the Exposure Draft. However, one change that the Board agreed upon was to limit effectiveness testing for hedges that had been in existence prior to the effective date of the standard to only the most current period presented in the financial statements. If a hedge is found to be effective as of the end of the current reporting period, it will be considered effective as of the date of implementation of the derivatives standard. The Board believed that benefits of requiring preparers to undergo effectiveness testing for historical periods did not surpass the cost associated with the testing. The Board tentatively agreed that the proposed effective date should be fiscal periods beginning after June 15, 2009. The Board did not believe that a disclosure of counterparty diversification based upon the total population of derivatives outstanding or notional amounts should be required. Finally, the Board considered disclosures of concentration of credit risk and group credit risk. The Board had already decided that concentration of credit risk would be a required disclosure at the previous teleconference meeting. However, the Board amended that decision so that this credit risk review also would incorporate an inquiry regarding "group concentration of credit risk." If appropriate, then disclosure of this group concentration of credit risk also would be required.

At the April 2007 teleconference, the Board agreed with the staff proposal that hedges of specific risks such as interest rate risk would not qualify under consistent critical terms when the hedging interest rate swap has an indexed variable payment adjusted by a constant. On the other hand, a total cash flow or fair value hedge may qualify provided that the hedged item is identical to the swap’s variable payment. The staff noted that their research indicated that based on current practice, this latter possibility would be very unusual. The Board tentatively decided that at a minimum, effectiveness testing would be required at the end of reporting periods. The Board tentatively agreed with the staff proposal that in the regression method of assessing hedge effectiveness, it would be acceptable to regress changes in fair values, historic cash payments, or historic interest rates. The Board tentatively agreed with the staff that references to an at-the-market swaption with zero fair value should be removed from the Exposure Draft. The staff indicated that the illustrations would be amended accordingly. The Board also tentatively decided the following issues. First, for hedge effectiveness testing purposes, other tests outside of those proposed in the Exposure Draft may be used as long as they provide a level of assurance of effectiveness that approximates the quantitative tests in the proposed text. Second, when testing a hedging relationship for the first time and the potential hedge fails the consistent critical terms method, a government should perform at least one more test in addition to consistent critical terms. And finally, when a hedging relationship is found to be ineffective after initial testing, a government would have the option of looking to other methods to continue hedge accounting but would not be required to apply those other methods.

At the May 2007 meeting, the Board tentatively agreed with the staff that the notion of hedgeable items should be organized between financial instruments and commodities. The next issue addressed was the notion of a synthetic variable-rate instrument. The staff recommended that limits be placed on the relationship between the hedging derivative and the hedged item to address the issue of overhedging. Limits, however, cause the synthetic variable-rate instrument to be substantively identical to the dollar-offset method of evaluating hedges and, hence, duplicative. The Board tentatively agreed with the staff that the synthetic variable-rate instrument method of evaluating hedges should be eliminated.

The Board also tentatively agreed with the staff that guidance regarding termination of hedge accounting needed to be revised and agreed with the staff’s proposed revised text. Finally, the Board tentatively agreed with the staff to include the use of the AAA/Aaa general obligation Municipal Market Data index as a benchmark interest rate.

At the May 2007 meeting and the June 2007 teleconference, the Board focused its discussion on the Exposure Draft, its appendices, and the plain-language supplement. The Board tentatively agreed with the staff that the requirements for the synthetic instrument method requiring that there should be mirror options in the potential hedging derivative instrument and the hedged item is not appropriate. The Board tentatively concluded that to avoid prescribing guidance that may not account for key factors, all formulas should be removed from the text of the standard. The Board tentatively concluded to retain the term hedge accounting in the Exposure Draft. The Board tentatively approved the draft of the plain-language supplement.

At the June 2007 meeting, the Board tentatively agreed to the several changes to the ballot draft of the proposed Statement, Accounting and Financial Reporting on Derivative Instruments. These changes included the use of the term potential hedging derivative instruments instead of derivative instruments that were associated with a hedgeable item but not yet determined to be effective. The Board also made changes to ensure that the phrase substantially offset was used consistently when referring to hedge effectiveness. The Board tentatively concluded that this phrase more accurately depicted the evaluation of effectiveness. Furthermore, the definitions of certain terms in the glossary were clarified and made consistent with the manner in which they were used in the document. Finally, the Board tentatively agreed that the accounting guidance should be presented in a single section in the document.

After tentatively agreeing with additional editorial changes, the Board unanimously voted to issue the Exposure Draft. The Exposure Draft was posted to the GASB website on June 29th.

Derivatives and Hedging—Minutes for Deliberations

Minutes of Meeting, June 12, 2008 Teleconference

Board discussion focused on the ballot draft of the Statement on Accounting and Financial Reporting for Derivative Instruments, and the related staff paper. The majority of the tentative decisions dealt with minor revisions to the text of the Statement. Substantive tentative decisions were as follows:

  • The transition guidance of the Statement should specify the accounting for any derivatives that are ineffective at the end of the first reporting period that the Statement is applied. If this is the case, governments should determine whether the derivative instrument was ineffective at the beginning of the reporting period. If it was ineffective at that time, the fair value of the derivative instrument at the end of the previous reporting period should be recorded as an adjustment to beginning net assets, and fair value changes during the period should be reported within investment revenue. If the derivative instrument was effective at the end of the previous reporting period, then the fair value changes of the derivative instrument should be reported within investment revenue, and there should be no adjustment to beginning net assets.
  • The definition of a financial instrument should remain as proposed in the Exposure Draft.
  • The provisions on termination events should refer to defeasances only, not refundings or defeasances.
  • The examples for new market conditions should not include disruptions in credit markets.
  • Illustration 1 should indicate that the 10 basis-point adjustment to the Securities Industry and Financial Markets Association swap rate is due to state-specific tax rates.

Minutes of Meeting, May 21-23, 2008

The Board’s discussion focused on the preballot draft of the Statement. The majority of the tentative decisions dealt with minor revisions to the text of the Statement, but some more substantive tentative decisions were reached. These tentative decisions were as follows:

  • Reorganize the text of the hybrid instruments requirements, including a fuller explanation of the term closely related.
  • Delete the fourth criteria of the other quantitative method (for both the financial instruments and commodities that address applying “fair value measurement in a manner consistent with the other criteria of [the Statement]”).
  • Keep the government-fund based illustrations but limit the illustration to the government-wide level.
  • Limit the swaption illustration to one in which the option is exercised, replacing the two swaption illustrations that were presented in the Exposure Draft.
  • Remove the separate consistent critical terms flowcharts and replace them with references to the appropriate paragraphs in the two summaries of effectiveness testing flowcharts.
  • Add a new disclosure paragraph that addresses interest rate risk disclosures for investment derivatives, updating the codification instructions to amend Statement No. 40, Deposit and Investment Risk Disclosures.
  • A ballot draft of a final Statement will be discussed at the June teleconference.

Minutes of Meeting, May 5, 2008 Teleconference

The Board’s discussion focused on topics contained in two staff papers: revised text to the Standard and synthetic guaranteed investment contracts (SGICs).

The Board tentatively agreed that:

  • Four criteria will be added to the consistent critical terms method to clarify the “on or about” language that was in the derivatives Exposure Draft—the time interval of the reference rates of the derivative and the hedgeable item, the rate reset dates, the frequency of the rate resets, and the periodic payments of the derivative and the hedged item. The text proposed in the staff paper should be added to the preballot draft, superseding the existing “on or about” language.
  • The guidance for SGICs should stay as proposed in the Exposure Draft.
  • Language will be added to the Basis for Conclusions to highlight current accounting guidance for loan commitments; text proposed in the staff paper should be included in the preballot draft.

Minutes of Meeting, April 15-17, 2008

The Board’s discussion focused on topics contained in four staff papers: loan commitments, reset dates in regard to the consistent critical terms method, effective date and transition, and the text of the final Statement.

The Board tentatively agreed to the following decisions:

  • Loan commitments should be scoped out of the project, and a definition of loan commitments should be added to the glossary.
  • The potential hedging derivative instrument and the hedgeable item should have identical reset intervals, and the dates of the resets should be within six days of one Entered Minutes 6 another in order to apply the consistent critical terms method (this tentative decision was subject to additional research to be conducted by staff before the May teleconference).
  • The effective date of the final Statement should be for periods beginning after June 15, 2009.
  • After considering the implications of the transitional provisions of the proposed
  • Statement to a government’s compliance with bond covenants, no changes were made to those provisions.
  • The footnote disclosures that address information from pricing services were retained and revised.

The Board also discussed the frequency of payments in relation to the swaps and bonds. The staff will report back to the Board at the May teleconference on the findings of its research efforts on this issue. In addition, the staff will provide the Board with the results of its research on the potential consequences of eliminating synthetic guaranteed investment contracts from the scope of the final Statement.

Minutes of Meeting, March 25, 2008 Teleconference

The Board’s discussion focused on four papers: the Basis for Conclusions on the synthetic instrument method, scope, hybrid instruments, and hedgeable items.

The Board tentatively agreed to the following decisions:

  • The Basis for Conclusions should be reworded with the text proposed by the staff that highlights the purpose of the synthetic instrument method.
  • The normal purchases and normal sales scope exception should continue to be included in the final Statement.
  • The final Statement should distinguish between contracts that should follow our existing insurance standards and contracts that should follow the final derivatives standard.
  • Examples that illustrate financial guarantee and insurance contracts should be provided in the derivatives implementation guide.
  • Regular-way securities and electric power contracts should be addressed in the derivatives implementation guide.
  • The recognition and measurement of hybrids should remain as proposed in the Exposure Draft.
  • Governments should cross-reference the bifurcated debt instrument noted in the debt note disclosure to the disclosed derivative in the summary of derivatives activity.
  • Guidance on both hedging groups of similar assets and liabilities, and what constitutes “observable facts” for expected transactions should be provided in the Derivatives Implementation Guide.
  • The Board requested follow-up reports on possible scope exceptions for loan commitments.

Minutes of Meeting, March 4-6, 2008

The Board discussion of derivative instruments focused on four topics contained in three staff papers: termination of hedge accounting, new market conditions, hedge effectiveness test parameters, and disclosures.

In its discussion of terminations, the Board tentatively agreed to the following:

  • The balance of the derivative’s deferral account should be reported in investment income once the hedge is terminated.
  • Changes will be made to Illustration 12 so that it focuses on required disclosures.
  • Guidance on how to treat the deferral account in the period a hedge is terminated will be provided in the Implementation Guide to the derivatives standard.
  • If a hedging derivative fails the effectiveness tests, hedge accounting should be terminated. Hedge accounting cannot be reapplied to the failed hedge.
  • Statement No. 23, Accounting and Financial Reporting for Refundings of Debt Reported by Proprietary Activities, should be amended to indicate that the calculation of the gain or loss on the refunding activity includes the amount that was reported in the deferral account.
  • If there is a debt refunding, the derivative deferral account should be included in the calculation of the net carrying amount of the old debt. Therefore, the disclosure requirements in Statement No. 7, Advance Refundings Resulting in Defeasance of Debt, also will be revised.
  • Once a hedge has been terminated, the prior hedging derivative can be associated with another hedgeable item as long as the new hedging relationship is accounted for separately from the previous hedging relationship.

In its discussion of new market conditions, the Board discussed the staff’s revisions to the text of the final standard. The Board recommended additional revisions and tentatively agreed that the text, as revised, should be included in the final standard.

In its discussion of hedge effectiveness test parameters, the Board tentatively accepted proposed language to be added to the Basis for Conclusions to outline the rationale behind the synthetic instrument method’s range of 90–11 percent.

In its discussion of disclosures, the Board tentatively agreed to the following:

  • Derivatives should be allowed to be aggregated by type in the financial statement note disclosures.
  • Primary governments should apply the component unit disclosure requirements of GASB Statement No. 14, The Financial Reporting Entity, to determine the materiality threshold of its component units’ derivatives.
  • Except for governments applying the “other evaluation method” provision, governments should not be required to disclose the method used to evaluate hedge effectiveness.
  • Governments should not be required to disclose a change in the method used to evaluate hedge effectiveness.
  • Footnote 9 in the Exposure Draft, related to pricing services, should be eliminated subject to the results of the staff’s inquiry to members of the Derivatives Task Force. Footnote 10, also related to pricing services, should be eliminated.
  • The identity of derivative counterparties should not be a required disclosure.
  • Credit risk disclosures as a whole should remain as proposed in the Exposure Draft. Credit risk disclosures focusing on collateral policies and postings should remain as proposed in the Exposure Draft, but this issue should be addressed in the Implementation Guide. Credit risk disclosures discussing master netting arrangements should remain as proposed in the Exposure Draft.
  • No additional disclosures regarding contract-by-contract collateral terms should be added. The terms commitments and contingent liabilities should be changed to contingent features.
  • Investment derivatives should be included in the summary of derivative activity disclosure. The staff will make inquiries to financial statement users on the Derivatives Task Force regarding whether a distinction should be made between cash flow and fair value hedges.
  • Investment derivatives should have additional disclosure requirements for credit risk as proposed in the Exposure Draft.

The Board discussed the FASB’s proposed changes to hedge accounting criteria. The purpose of the discussion was to determine whether any of the proposed changes should affect the GASB’s conclusions. After thoroughly considering the proposed changes, the Board tentatively decided to continue on with its current proposal for accounting for derivatives.

Minutes of Meeting, February 12, 2008 Teleconference

The Board’s discussion focused on hedge effectiveness testing. The Board discussed an alternative qualitative method proposed by a Board member that focused on percentage of LIBOR swaps. After careful analysis, the Board reaffirmed that quantitative analysis is fundamental to testing the effectiveness of percentage of LIBOR swaps; therefore, no changes were made.

Minutes of Meeting, January 22-24, 2008

The Board’s discussion of the derivative instruments project focused on topics contained in two staff papers: the recognition and measurement of derivatives and the evaluation of hedge effectiveness for classification and recognition purposes.

The Board tentatively came to the following conclusions:

  • All derivatives should be measured and reported on the statement of net assets at fair value.
  • The fair value changes of effective hedging derivatives should be reported in the statement of net assets as deferrals. A discussion will be included in the Basis for Conclusions that addresses how deferred inflow and deferred outflow accounts do not affect a government’s net assets.
  • Hedge accounting should be required if an effective hedge is present.
  • Documentation of the hedging relationship should not be a requirement to qualify for hedge accounting. However, the Board’s support for proper documentation of both the hedging relationship and the evaluation of effectiveness will be emphazied in the Basis for Conclusions, even though it is not a hedge accounting requirement.
  • Derivatives tied to ingredients and components of a commodity are potential hedging derivatives only if the corresponding hedgeable item is the ingredient or component, and not the commodity as a whole. The boundaries of what is considered a component of a commodity will be clarified in the derivatives Implementation Guide.
  • There should be multiple methods allowed for evaluating hedge effectiveness.
  • The language from the Exposure Draft will be modified in the final standard to restrict the use of the synthetic instrument method to hedges in which the notional amount of the hedgeable item matches the notional amount of the underlying hedging derivative.
  • The ranges for the synthetic instrument method and the dollar-offset method should remain as proposed in the Exposure Draft.
  • There should not be a stub period provision in the dollar-offset method.
  • The regression method should remain in the standard. Additionally, the final standard should not indicate the minimum number of data points to be included in the analysis. Comments received that were specifically related to this topic may be addressed further at a future Board meeting.
  • The provision for "other evaluation methods" should not be eliminated. Comments received that were specifically related to this topic may be addressed further at a future Board meeting.

The Board did not reach a consensus on the following issues discussed:

  • While discussing the bond covenants issue, the Board considered a comment letter that described the cost of modifying bond covenants for the proposed standard. This discussion led to a dialogue about the accounting consequences of a previously effective hedge becoming ineffective. The Board asked the staff to prepare a paper that describes the Exposure Draft’s proposals for the termination of a hedging relationship and the basis for approaches taken by other standards setters.

After discussing new market conditions, the Board did not reach an agreement on whether or not the definition should be modified. There was tentative agreement that the notion of new market conditions should be included in the standard but that the wording of its definition and the possibility of including examples will be further considered. The text that addresses new market conditions in the Exposure Draft will be revised for deliberation by the Board at a future meeting and for discussion of potential "new market conditions" disclosures.

Minutes of Meeting, December 11-13, 2007

The Board discussed three topics: the results of the field test, the measurement of derivatives in the governmental fund statements, and the criteria to be used in the consistent critical terms method. In the discussion of the derivatives field test, the Board primarily focused on the expected costs of initial implementation and ongoing application of the Exposure Draft if adopted. The Board expressed its appreciation to the governments that completed the field test and felt the information provided was useful toward an evaluation of implementation costs. The discussion was bolstered by a discussion of comment letters that also address implementation costs.

Regarding the reporting of derivatives in the governmental fund financial statements, the Board tentatively decided to exclude this issue from the scope of the final standard. This tentative decision was made in light of the deliberations that are currently underway on the concepts statement project on recognition and measurement attributes.

The Board made a number of tentative decisions with respect to the consistent critical terms method. In general, the Board tentatively decided to adhere to the proposed criteria but to provide additional clarity where it might be beneficial.

Minutes of Meeting, June 19-21, 2007

The Board tentatively agreed to the several changes to the ballot draft of the proposed Statement, Accounting and Financial Reporting on Derivative Instruments. These changes included the use of the term potential hedging derivative instruments instead of derivative instruments that were associated with a hedgeable item but not yet determined to be effective. The Board felt that this term would accurately describe the instrument and would avoid confusion between derivatives that could qualify for hedge accounting and investment derivative instruments. The Board also made changes to ensure that the phrase substantially offset was used consistently when referring to hedge effectiveness. The Board tentatively concluded that this phrase more accurately depicted the evaluation of effectiveness. Furthermore, the definitions of certain terms in the glossary were clarified and made consistent with the manner in which they were used in the document. Finally, the Board tentatively agreed that the accounting guidance should be presented in a single section in the document. After tentatively agreeing with additional editorial changes, the Board unanimously voted to issue the Exposure Draft.

Minutes of Meeting, May 29, 30, and June 2, 2007 Teleconferences

The Board focused its discussion on the Exposure Draft, its appendices, and the plain-language supplement. The Board tentatively decided that the language surrounding the purpose of hedging needed to be consistent and tentatively agreed with the changes that the staff proposed. The Board tentatively agreed with the staff that the bulk of the background discussion surrounding cash flow and fair value hedges should remain in the Basis for Conclusions. However, the Board asked the staff to prepare a draft of the primary points that could be considered for inclusion in the standard to ensure that the remaining references to cash flow and fair value hedges were in proper context. The Board tentatively agreed with the staff that the requirements for the synthetic instrument method requiring that there should be mirror options in the potential hedging derivative instrument and the hedged item is not appropriate. The Board also tentatively concluded that to avoid prescribing guidance that may not account for key factors, all formulas should be removed from the text of the standard. The Board also tentatively decided that the illustration summaries that were removed provide a good explanation of the illustrations and their respective purposes. Thus, the Board tentatively decided that final version of the Exposure Draft should have the illustration summaries included. The Board tentatively agreed that the illustration that depicted a forward starting swap should be included as an illustration in the Exposure Draft. The Board tentatively concluded to retain the term hedge accounting in the Exposure Draft. The Board tentatively approved the draft of the plain-language supplement.

Minutes of Meeting, May 1-3, 2007

During this month’s Board meeting a number of issues regarding the Derivatives and Hedging project were deliberated. First, the Board indicated that questions should be posed in the Exposure Draft. No questions, however, were agreed upon at this meeting. Next, the Board tentatively agreed with the staff that the notion of hedgeable items should be organized between financial instruments and commodities. The next issue addressed was the notion of a synthetic variable-rate instrument. The staff recommended that limits be placed on the relationship between the hedging derivative and the hedged item to address the issue of overhedging. Limits, however, cause the synthetic variable-rate instrument to be substantively identical to the dollar-offset method of evaluating hedges and, hence, duplicative. The Board tentatively agreed with the staff that the synthetic variable-rate instrument method of evaluating hedges should be eliminated.

The Board then discussed issues associated with "the other methods" approach of evaluating hedge effectiveness. The Board tentatively agreed to retain the approach. The staff will make revisions to this proposal by bringing material from the Basis for Conclusions into the Standards section and more fully explaining the notion of an effective hedge. The Board also tentatively agreed with the staff that guidance regarding termination of hedge accounting needed to be revised and agreed with the staff’s proposed revised text. Finally, the Board tentatively agreed with the staff to include the use of the AAA/Aaa general obligation Municipal Market Data index as a benchmark interest rate.

The Board reviewed the text of a preballot draft and made several edits. The staff agreed to provide an alternative format for organizing the text that addresses hedge effectiveness at the May teleconference. As noted above, organizing the text by hedged item—financial instrument versus commodities—received the most attention.

Minutes of Meeting, April 17, 2007 Teleconference

The Board addressed unfinished issues and conducted a first review of the draft text of a proposed derivatives standard. The first issue addressed was consistent critical terms. The Board agreed with the staff proposal that hedges of specific risks such as interest rate risk would not qualify under consistent critical terms when the hedging interest rate swap has an indexed variable payment adjusted by a constant. On the other hand, a total cash flow or fair value hedge may qualify provided that the hedged item is identical to the swap’s variable payment. The staff noted that their research indicated that based on current practice, this latter possibility would be very unusual.

Next, the Board tentatively decided that at a minimum, effectiveness testing would be required at the end of reporting periods. The Board also agreed with the staff that a forthcoming implementation guide should indicate where preparers may find the data necessary to perform a regression analysis (such as names of organizations and websites). The Board also noted that the role of the GASB should not include being a source of data. Finally, the Board tentatively agreed with the staff proposal that in the regression method of assessing hedge effectiveness, it would be acceptable to regress changes in fair values, historic cash payments, or historic interest rates.

The next issue for deliberation was swaptions. The Board tentatively agreed with the staff that references to an at-the-market swaption with zero fair value should be removed from the Exposure Draft. The staff indicated that the illustrations would be amended accordingly.

The last item the Board deliberated was the proposed text of the standard, to which the Board made certain revisions. The Board also tentatively decided the following issues. First, for hedge effectiveness testing purposes, other tests outside of those proposed in the Exposure Draft may be used as long as they provide a level of assurance of effectiveness that approximates the quantitative tests in the proposed text. Second, when testing a hedging relationship for the first time and the potential hedge fails the consistent critical terms method, a government should perform at least one more test in addition to consistent critical terms. And finally, when a hedging relationship is found to be ineffective after initial testing, a government would have the option of looking to other methods to continue hedge accounting but would not be required to apply those other methods.

Minutes of Meeting, April 3-5, 2007

The Board began the derivative’s discussion by tentatively deciding to accept the staff’s revised version of the "derivative summary table" disclosure as opposed to the version previously included in the Preliminary Views (PV). The Board agreed with the staff that the new table more clearly outlines the changes and derivative activities that had taken place during the reporting period. Next, the Board tentatively agreed with the staff recommendation that for investment derivatives, detailed derivative terms and individual fair values should not be a required disclosure; however, for hedging derivatives, the detailed derivative term disclosure requirements of Technical Bulletin (TB) No. 2003-1, Disclosure Requirements for Derivatives Not Reported at Fair Value on the Statement of Net Assets, should be continued. The Board agreed with the staff’s recommendation that for noninvestment derivatives, the detailed derivative term disclosures requirements of the TB should be continued.  The Board considered alternative approaches to presenting derivative disclosures—allow governments to refer to separately issued financial statements of discretely presented component units, as required supplementary information, and a method similar to one used in Statement No. 40, Deposit and Investment Risk Disclosures. The Board tentatively decided that there should be no change from the current requirement. The next set of issues dealt with hedges of expected transactions. The Board agreed with the staff recommendation that an expected transaction can be a hedgeable item. Furthermore, the Board agreed with the staff’s depiction of how the various hedge effectiveness methods would be applied to hedges of expected transactions.

The Board then focused on the effective date and transition guidance of the derivatives standard. The Board agreed with the staff recommendation that the transition guidance in the PV be carried forward to the Exposure Draft. However, one change that the Board agreed upon was to limit effectiveness testing for hedges that had been in existence prior to the effective date of the standard to only the most current period presented in the financial statements. If a hedge is found to be effective as of the end of the current reporting period, it will be considered effective as of the date of implementation of the derivatives standard. The Board believed that benefits of requiring preparers to undergo effectiveness testing for historical periods did not surpass the cost associated with the testing. The Board tentatively agreed that the proposed effective date should be fiscal periods beginning after June 15, 2009.

The Board did not believe that a disclosure of counterparty diversification based upon the total population of derivatives outstanding or notional amounts should be required. Finally, the Board considered disclosures of concentration of credit risk and group credit risk. The Board had already decided that concentration of credit risk would be a required disclosure at the previous teleconference meeting. However, the Board amended that decision so that this credit risk review also would incorporate an inquiry regarding "group concentration of credit risk." If appropriate, then disclosure of this group concentration of credit risk also would be required.

Minutes of Meeting, March 12, 2007 Teleconference

The Board deliberated disclosures in relation to derivatives. The first issue discussed was whether or not ineffectiveness and hedge-specific information should be required disclosures. The Board tentatively decided that this information should not be a required disclosure. The basis for the decision was the cost-benefit constraint of requiring preparers to calculate hedge ineffectiveness for an otherwise effective hedge. The Board considered existing requirements to disclose specific terms and fair values but did not reach a decision at this meeting. The staff indicated that a separate paper would be prepared for the next Board meeting to assist the Board in its deliberations. Next, the Board tentatively decided that for investment derivatives, the disclosure requirements of Statement No. 40, Deposit and Investment Risk Disclosures, should be applied. The Board believes that those disclosures would ensure that investments in derivatives were recorded in a manner consistent with other financial investments.

The next set of issues that the Board deliberated related to disclosures of termination risk. The Board tentatively agreed with the staff that disclosures regarding collateral posting requirements and triggers should be required. The Board, however, did not believe that a sensitivity analysis disclosure should be required.

The final set of issues that the Board deliberated was regarding disclosures of credit risk. The Board agreed with the staff in tentatively deciding that required disclosures should include disclosure of the net exposure to credit risk and the aggregate amounts by which netting arrangements and counterparty collateral or other security reduce a government’s gross exposure to credit risk. The Board also tentatively decided that a concentration of credit risk disclosure should be required. This disclosure would be based on the net exposure to credit risk associated with derivatives with an individual counterparty. The Board did not believe that a specific threshold percentage should be provided in the requirement as to when a concentration should be disclosed. The Board believed that this disclosure should be required for "significant concentrations" of derivatives with individual counterparties. The Board discussed whether disclosure of the extent of diversification among counterparties to derivatives should continue to be required in light of the required concentration of credit risk disclosure; however, no tentative decision was reached at this time. Lastly, the Board tentatively decided that a government should be required to disclose its policies related to counterparty collateral requirements and netting arrangements.

Minutes of Meeting, February 20–22, 2007

The Board deliberated a number of issues during this month’s Board meeting. First, the Board tentatively decided that expected transactions would be split into two groups, those that possess a contractual/commitment type component and those that do not. Next, the Board tentatively agreed that only those expected items with a contractual/commitment-type component will be eligible for effectiveness testing using either the consistent critical terms (CCT) method or the synthetic instrument method. Furthermore, the Board tentatively decided that language should be added to the Exposure Draft that requires effectiveness monitoring on an ongoing basis throughout the hedge period when applying the CCT method to expected transactions.

The next issue that the Board deliberated was in regard to option-based hedges. The Board tentatively agreed with staff that these types of hedges should be evaluated for effectiveness according to the objectives of the hedges. The Board also determined that stepped fixed rate contracts cannot meet the requirements for use of the CCT method of assessing hedge effectiveness. However, the Board decided to allow the use of the CCT method for futures and forward contracts. Prior to this decision, the method was only allowed to be used for interest rate swaps.

Continuing with the discussion on effectiveness testing, the Board discussed the use of quantitative methods. The Board tentatively decided that governments will be required to test all the methods available to them at the inception of a hedging relationship before the government could determine that a hedging relationship is ineffective. During the life of a hedging relationship, a government may switch from one method to another as long as doing so does not make an effective hedge become ineffective. Finally, the Board deliberated the amount of testing that would be required before a hedge could be classified as ineffective during its life. A government will be required to test all available methods (even methods that the relationship had failed in prior periods) before a hedge can be classified as ineffective. The Board realized that such an exhaustive hedge effectiveness testing requirement could place an additional burden on preparers. To address that concern, the Board encouraged the staff to research ways of reducing the difficulty of applying regression analysis to common hedge applications.

Following the deliberation of effectiveness testing, the Board discussed the treatment of ineffective hedges. The Board unanimously agreed that once a hedge has been determined to be ineffective, that relationship cannot be determined to be effective later in the future. Then the Board tentatively decided that at the point that a hedging relationship is determined to be ineffective, the entire deferral account would be recognized in the change statement.

Minutes of Meeting, January 29, 2007 Teleconference

During this month’s teleconference, the Board continued its discussion about the use of quantitative methods in assessing hedge effectiveness. First, the Board looked at regression analysis. The Board agreed with the staff that there were some practical difficulties in implementing the method; however, it believed that it was a valid manner in which to assess hedge effectiveness. Some of these difficulties included lack of data for all historical periods and the potential cost for governments to use the method. Nonetheless, the Board tentatively agreed that the method should continue to be used as a way in which to assess hedge effectiveness. The Board also approved the methodology that the staff illustrated in using regression. In analyzing the methodology, the Board agreed that regression analysis needs to be performed in a manner that would ensure statistically valid results. However, the Board did not want to specify a minimum number of data points necessary to perform the analysis. The Board does plan to stress that the regression method needs to be performed using "accepted statistical methods." Finally, the Board affirmed the critical values currently required under the Preliminary Views (PV) document and concluded that no other requirements were necessary.

The next quantitative method that the Board deliberated was the dollar-offset method. The Board affirmed that the method was a valid manner in which to assess hedge effectiveness.

The next issue that the Board deliberated was swaptions. The Board concurred with the staff proposal to continue using the hybrid instrument proposal that has been outlined in the PV. The Board also tentatively agreed that further guidance regarding this method should be offered in an implementation guide. Next, the Board tentatively decided that when valuing an option such as in the case of a swaption arrangement, the option should be bifurcated into its time value and intrinsic value. Furthermore, the intrinsic value should be evaluated in terms of the hybrid instrument. Following this discussion, the Board looked at written options in a synthetic refunding. In regard to this issue, the Board decided a written option in a synthetic refunding should be regarded as a hybrid instrument and a hedge of the future issuance of debt. The Board then agreed that this hybrid instrument treatment is consistent with the notion that the accounting standard would be requiring derivatives to be measured and reported at fair value. A cross reference between derivative and hybrid instrument guidance was approved.

The last issue that the Board deliberated in regard to derivatives included financial guarantees and insurance. The Board agreed with the staff that a scope exception for certain financial guarantee arrangements similar to that in paragraph 10(d) of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, should be incorporated into the derivatives standard. This exception is consistent with the scope exception for certain insurance contracts in the PV, as well as with the accounting for insurance arrangements present in GASB Statement No. 10, Accounting and Financial Reporting for Risk Financing and Related Insurance Issues. Next, the Board examined a subset of derivatives that had physical variables as the underlying. The Board decided to exclude these types of derivative transactions from the scope of the proposed derivatives standard.

Minutes of Meeting, January 9-11, 2007

Continuing the discussion from the December teleconference, the Board tentatively decided that settlement payments arising from interest rate locks should be reported as other financing sources or uses in governmental funds. The Board also tentatively decided that in governmental fund statements, hedging derivatives associated with hedges of expected transactions should be reported in the fund that will report the hedged transaction.

The Board also addressed a number of questions stemming from respondents’ comments on the consistent critical terms method of evaluating hedges. Several of these questions had implications beyond application of that method. The Board tentatively decided that:

  • Neither LIBOR nor a percentage of LIBOR could be considered a benchmark interest rate for state and local government tax-exempt debt.
  • Under any method of evaluating hedge effectiveness, an accounting hedge of interest rate risk may be constructed even if the variable rate of the hedged tax-exempt debt is based on auction or remarketed rates as opposed to an index.
  • A hedge of interest rate risk may qualify for application of the consistent critical terms method to assess hedge effectiveness if the variable rate of the debt is set by auction or remarketing and the variable rate of the swap is SSI. (The Board had previously determined that SSI, formerly known as BMA, would be considered the benchmark rate for tax-exempt debt.)
  • Hedges of changes in overall cash flows of a hedged item may qualify for application of the consistent critical terms method to assess hedge effectiveness if the basis for determining the variable swap payment exactly matches the basis for determining the variable payment of the hedged item.
  • A hedge of interest rate risk by which the variable leg of the swap is based on SSI with an adjustment of a fixed amount, for example SSI minus 10 basis points, that reflects state-specific tax structures may be evaluated under the consistent critical terms method. Some Board members asked whether all states with marginal tax rates different than the national average would price at different rates. Staff indicated more research could be appropriate and that additional or alternative recommendations would be presented to the Board if appropriate.
  • Zero fair value means that a swap’s price is within a dealer’s bid/offer spread.
  • When a government’s swap transaction fees, such as attorney and advisor fees, are paid by the counterparty, those fees should be reported as expenditures/expenses. When those fees are recovered by the counterparty from the government by way of an off-market rate, a hybrid instrument exists and should be evaluated accordingly, for example, a borrowing may have been entered.
  • A hedge of a risk associated with only a portion of an asset, liability, or expected transaction could meet the requirements of the consistent critical terms method if the notional amount of the swap and the hedged portion of the item are the same.
  • The term on or about was used in the Preliminary Views (PV) document in connection with the consistent critical terms and the synthetic instrument methods. The number of days contemplated by that term is a matter of professional judgment.

The next paper the Board deliberated focused on the synthetic instrument method. The Board made three tentative decisions regarding this method. First, the Board decided that the critical values for this method should be presented as requirements. Next, the Board agreed with the staff that the method should be limited to hedges of changes in overall cash flows. That decision means that hedges of interest rate risk may not be evaluated using this method. Finally, the Board decided that the range of the critical values of the method will remain between 90 to 111 percent.

The Board began to consider a paper concerning the quantitative techniques for evaluating hedge effectiveness; however, it was unable to complete deliberating all of the relevant issues. The Board will continue with this paper at the next Board teleconference. Nonetheless, the Board tentatively decided that regression will continue to be used as a method of evaluating hedge effectiveness and that the method outlined in the paper appeared to be a reasonable manner in which to apply the method. Finally, the Board tentatively agreed that the critical values in the PV seemed to be reasonable.

Minutes of Meeting, December 18, 2006 Teleconference

The Board examined a number of issues at this meeting. The first issue discussed was whether or not the Board would propose that the Securities Industry and Financial Markets Association Swap Index (an index that has replaced BMA, referred to as SSI in these minutes) be considered as a proxy for a benchmark rate in the municipal tax exempt market for state and local governments. The Board tentatively agreed to accept SSI as a proxy, but it also acknowledged that SSI is not a risk free rate and that bonds of state and local governments do not actually pay an SSI rate. In relation to taxable debt, the Board tentatively agreed that the appropriate benchmark interest rates would be either the U.S. Treasury rate or LIBOR.

Next, the Board tentatively decided that investments that were measured at fair value are not hedgeable items. Subsequently, the Board discussed whether or not it should limit the types of risks that can be hedged for qualifying transactions or events. The Board tentatively agreed that it would be helpful to provide examples of some typical risks that are hedged using derivatives, but it did not feel it was necessary to limit the types of risks that were able to be hedged so long as they are measurable. The Board also clarified that foreign currency risk was a hedgeable item.

The final issue was the reporting of hedges and the hedged item. The Board tentatively agreed that in funds reporting as a business type activity, the hedging derivative should be reported in the same fund as the hedged item. However, the Board did not reach a tentative conclusion as to whether or not such a stipulation was necessary in the governmental fund financial statements. The Board asked the staff to research the topic further to determine whether or not such a requirement would be needed.

Minutes of Meeting, November 29–December 1, 2006

The Board addressed the treatment in governmental fund statements of up-front payments that result from derivative transactions. The staff recommended that up-front payments be considered borrowings and treated as such in governmental fund statements. The Board tentatively agreed with this recommendation.

The Board then turned its attention to hedge accounting-whether hedge accounting should continue to be proposed and whether deferrals should be the means of effecting hedge accounting. The staff suggested that the use of hedge accounting was necessary in governmental funds based on current accounting conventions and proprietary/government-wide financial statements based on the notion of interperiod equity. The entire Board tentatively agreed that hedge accounting was necessary in the government-wide financial statements. Certain members disagreed as to its need in governmental fund statements. Their concern was focused on hedging derivatives entered into in conjunction with the issuance of debt. They believed that because long-term debt is not reported in governmental fund statements, hedging derivatives also should not be reported. Other members believed that derivatives should be reported in the governmental fund statements because they are financial resources. In the end, a majority of the Board tentatively agreed with the staff recommendation of applying hedge accounting to all financial statements. The Board then addressed whether deferrals, as a means to enact hedge accounting, were appropriate. The Board tentatively agreed that the use of deferrals to enact hedge accounting was appropriate for the government-wide statements. Some members, however, took issue with hedge accounting in governmental fund statements for the same reasons that were noted above. Nonetheless, a majority of the Board tentatively agreed with the staff's recommendation of using deferrals for hedge accounting in governmental fund financial statements.

The Board then considered hedging requirements-conditions necessary to classify a derivative as a hedging derivative. Three issues were considered. First was whether hedge accounting should be required for all derivatives that meet the hedge criteria. The Board tentatively agreed that derivatives employed as hedging derivatives should be accounted for using hedge accounting. The next issue was whether management's declaration of their objective to establish a hedge should include an identification of the hedged risk and the hedged item. The Board tentatively decided to take an alternate approach. The Board recognized that there are two competing interests. One interest is to ensure consistent reporting among transaction types and entities, while the other interest is to prevent misapplication of the standard to achieve a particular accounting outcome. Thus, the Board tentatively voted in favor of eliminating management's objective as a criterion for a derivative to be classified as a hedge because it could be subjective, and the Board did not want to impose a documentation requirement. The staff was asked to consult with the derivatives and hedging task force to get their comments on this issue before the Board took a final position on this issue. The final issue was the usage of quantitative techniques in order to test for hedge effectiveness. The Board decided to table the issue until it deliberates each of the methods individually; then it should be able to evaluate the attributes of each method and determine if some methods can appropriately substitute for others.

The staff presented to the Board three potential research topics that the Board may want to request further study on. The first topic was whether to use tax law as a basis of determining hedge effectiveness. Because tax law on this point has been developed for a different purpose, the staff recommended against researching this topic further. The Board tentatively agreed with the staff's recommendation. The second potential research topic was the notion that hedges that lowered a government's cost of borrowing should be considered effective hedges. The majority of the Board tentatively did not agree to research this topic because they felt that while lower borrowing costs were beneficial, the primary purpose of entering into a hedge is to manage risk. The final proposal was that once a hedge is determined to be effective at inception, it should continue to be effective throughout its life. Some respondents believed that financial statement users would find it difficult to follow the changes that result from a change in classification of a derivative due to effectiveness testing. Another group of respondents believed that if termination risk can be appropriately managed, then a hedge that has proven to be effective at inception could continue to be effective for the life of the hedge. The Board tentatively agreed with the staff's recommendation to not pursue this proposal. The Board noted that there may be other methods of evaluating hedge effectiveness currently under research that may establish effectiveness of a hedge for multiple years. The staff was asked to determine whether those methods could be useful.

Minutes of Meeting, November 6, 2006 Teleconference

The Board considered how to address credit risk in regard to synthetic guaranteed investment contracts (SGICs). The staff proposed that credit risk be considered by evaluating the combined resources provided by the SGIC's investments and the wrapper provider. A concentration of credit risk disclosure will be studied when the Board addresses derivative disclosures. The Board tentatively agreed to propose that a wrapper provider should meet "financially responsible" criteria as a qualification for contract value reporting. Next, the staff provided the Board with language for the Exposure Draft (ED) in regard to SGICs. This language included the requirements for contracts to be considered "benefit responsive" to be accounted for at contract value. The proposed ED language contained disclosure requirements for SGICs. Edits were proposed and tentatively approved by the Board.

In order to further clarify disclosure requirements, the staff also provided the Board with a disclosure illustration. The Board agreed with the staff's proposal that SGIC disclosures be based on existing disclosure requirements found in Statements No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools, and No. 40, Deposit and Investment Risk Disclosures. Some Board members wanted more disclosure of the specific measures that governments were using to mitigate their exposure to credit risk, but a majority of the Board tentatively agreed with the staff's proposal and language.

Minutes of Meeting, October 10–12, 2006

Four main issues were brought in front of the Board. The first two issues dealt with the accounting treatment for up-front payments that governments may receive in certain financial arrangements involving derivatives. First, the Board was asked to examine the accounting treatment for up-front payments in regard to interest rate swaps. In these arrangements, the governments agree to accept an above market interest rate to pay the counterparty, in exchange for an up-front payment. The Board agreed with the staff’s recommendation that these up-front payments should be treated as liabilities that are amortized over the life of the derivative because the government is constructively borrowing the funds from the counterparty and would be obligated to return these funds in the event of a termination. Next, the Board looked at instances related to forward delivery agreements in which the government accepts a below market rate of return from the counterparty in exchange for an up-front payment. The Board agreed with the staff’s recommendation that the up-front payment in this instance is also a liability; however, the Board did not reach a conclusion on the presentation of these transactions in governmental funds. The Board felt that this reporting in the government-wide statements would provide consistency between the accounting treatments of both financial arrangements involving up-front payments and would best reflect the economic substance of the transactions.

The next two issues dealt with the measurement of derivatives within the financial statements. The Board agreed with the staff’s recommendation that derivatives should be measured at fair value in the government-wide financial statements. The final issue that the Board considered was whether derivatives should be measured at fair value in the governmental fund financial statements. After discussion regarding a need to study government funds in the attributes project, the majority of the Board decided that reporting derivatives at fair value in the fund financial statements was the best alternative. The alternative considered would have measured investment derivatives at their historical prices when they are reported in governmental funds. The Board asked the staff to address measurement of derivatives in governmental funds in the Exposure Draft’s Basis for Conclusions. That discussion should explain why the Board believes a fair value measurement is the best accounting treatment, given the current model and Statement No. 31, Accounting and Financial Reporting for Certain Investments and for External Investment Pools.

Minutes of Meeting, September 25, 2006 Teleconference

The Board discussed issues regarding synthetic guaranteed investment contracts. The staff provided the Board with additional background information and asked the Board to look at three specific issues. First, the Board was asked whether or not they agreed with the manner in which the staff had addressed their concerns from the previous meeting about credit risk. The staff proposed using a standard that involved the use of a "financially responsible" criterion. The staff noted that wrap providers are scrutinized because they have an obligation to provide liquidity if investment fair values are insufficient to cover withdrawals from the plan. Furthermore, wrap providers have an interest in making sure that the investment portfolios they have guaranteed are high quality. Thus, by considering the totality of the environment in which these financial arrangements function, the majority of the Board believed that their concerns over credit risk were adequately addressed.

The Board was asked if the contracts that were eligible for possible contract value treatment should be limited to those contracts that are benefit responsive. The Board agreed with the staff’s conclusion by using this factor to limit those contracts that would receive the possible contract value accounting treatment.

Finally, the Board was asked to look at four possible accounting treatments for benefit-responsive contracts—fair value on the balance sheet, FASB staff position methodology, deferral method, and contract value method. A majority of the Board felt that the contract value method was the best accounting treatment. These Board members assumed that appropriate fair value disclosures for these contracts would be required. Furthermore, the staff was asked to prepare possible disclosure language and a potential financial statement presentation so that the Board could get a more realistic picture as to how these arrangements would be portrayed in the financial statements.

Minutes of Meeting, August 29-31, 2006

The Board discussed the potential impact that synthetic Guaranteed Investment Contracts (GICs) may have on the proposed standard for derivatives and hedging (Paper 2). GICs are issued by insurance companies generally in connection with deferred compensation, defined contribution pension, and college savings plans. Synthetic GICs are financial arrangements involving a portfolio of investments owned by the government supported by a wrapper contract. The wrapper provides additional liquidity to make payments to participants in the event that the fund’s assets are insufficient. The staff acknowledged that one approach to these types of investments was to simply scope them out of the proposed standard. However, the staff believed and the Board tentatively concurred that these transactions met the tentative definition of a derivative; however, additional research will be conducted to verify that conclusion.

Two significant matters regarding synthetic GICs were brought to the Board’s attention. First, the Board was asked whether it needed more background information before making decisions on the topic. The Board indicated that it believed it had sufficient background information at this time. Second, the Board was asked to consider whether the staff should research possible means of communicating fair value and contract value in the financial statements. The Board agreed to consider the staff’s recommendation on measurement and recognition alternatives at a future teleconference. No matter which approach was taken, the staff indicated that existing literature (for example, current pension and OPEB standards) could be impacted depending on the Board’s conclusions. Some members felt that it was feasible for potential changes to be addressed in the proposed Statement rather than amending existing literature; however, no position was taken regarding how the changes, if any, would be addressed.

During its deliberations, the Board considered the current FASB guidance on the issue that is contained in FASB Staff Position (FSP) AAG INV-1 and SOP 94-4-1, "Reporting of Fully Benefit-Responsive Investment Contracts Held by Certain Investment Companies Subject to the AICPA Investment Company Guide and Defined-Contribution Health and Welfare and Pension Plans." One concern the Board had with the methodology was that there needed to be some manner in which to incorporate credit risk of both the portfolio and the wrapper provider into the "value" of the synthetic GIC. The use of credit ratings to fulfill this purpose was discussed; however, the Board was still open to considering other possibilities. The Board asked the staff to research the approaches in which both the contract value and fair value of the investments could be communicated to the user and an appropriate manner in which to bring a measure of credit risk into consideration. Also, the Board asked the staff to consider in its research which information is more suitable for the face of the financial statements and which should be conveyed through disclosure.

Next, the Board was asked to examine the staff’s analysis on three overriding themes (global issues) that were noticed during the examination of comments to the PV document. The first global issue was that the PV document is not consistent with FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities. The Board acknowledged that careful consideration was given to existing standards (including FASB Statement 133), while designing the PV document. However, the Board agreed with the staff analysis that due to the unique environment in which governmental entities function, a wholesale adoption of FASB guidance would not be a viable solution. The second global issue that was brought to the Board’s attention was that some respondents felt that a disclosure model would be more appropriate for governmental entities rather than the recognition model that the PV document proposed. While the Board agreed that disclosures do provide valuable information for the users of financial statements, they also noted that disclosures are not an adequate substitute for recognition in the financial statements, as stated in GASB Concepts Statement No. 3, Communication Methods in General Purpose External Financial Reports That Contain Basic Financial Statements. Moreover, the Board concurred with the staff’s analysis that since derivatives are currently on the balance sheet at historical cost, the true question is a measurement or valuation issue rather than one of fundamental accounting. The Board concluded that a recognition model that incorporated disclosures would ensure that users are fully aware of a government’s financial position. The last global issue that the Board looked at was regarding the complexity of the topic and the fact that many governments may lack a staff with sufficient experience to understand and apply the accounting guidance proposed in the PV document. The Board recognized that the topic was inherently complex but felt that the accounting treatment applied to the transaction had to accurately depict the transactions that the governmental entities entered into. Nonetheless, the Board felt that it would take steps to facilitate the education of governmental entities on the topic of derivatives. This would be accomplished through collaboration with various constituent organizations as well as through the Board members and staff’s presentations on the topic. The Board also dedicated itself to making the proposed guidance as understandable as possible and to use consistent terminology with existing literature.

The last matter the Board discussed was the revised project plan and updates on due process activities. The Board tentatively concluded that the current timetable while ambitious should be followed.

Minutes of Meeting, July 11-13, 2006

Members of the Stable Value Investment Association made a presentation regarding guaranteed investment contracts (GICs) and synthetic GICs. No Board decisions were made.

Minutes of Meeting, April 18-20, 2006

The Board discussed the ballot draft of the Preliminary Views document for derivatives and hedging as well as the plain language supplement that will accompany the document. The discussion focused on changes, such as adding formulas for the synthetic instruments method when the government is trying to achieve a synthetic fixed rate as well as a formula for the dollar-offset method. The Board voted unanimously to approve the document. The Preliminary Views document will be posted on the website, www.gasb.org, on Friday, April 28th.

Minutes of Meeting, April 4, 2006 Teleconference

The Board discussed the preballot draft of the Preliminary Views document for derivatives and hedging as well as the plain-language supplement that will accompany the document. The discussion focused on edits to make the document more readable, as well as edits to make the wording consistent throughout the document. A ballot draft will be presented to the Board at the April meeting.

Minutes of Meeting, March 7-9, 2006

The Board studied draft language of the Preliminary Views (PV) document, which had been updated to reflect the Board’s discussion at the February 2006 teleconference (Paper 1a). The Board indicated that the PV should contain additional language in the summary section that elaborates on the objectives of the document and its component pieces. The Board tentatively recommended that the terms highly and sufficiently be dropped as adjectives preceding the term effective. A derivative may be highly effective but not sufficiently effective to qualify for hedge accounting. The Board has also requested that Staff focus on clearly defining the term effective on a more conceptual basis.

The Board sought revision to the manner in which synthetic rate instrument hedges are cast in the PV document. The Board tentatively agreed to eliminate the characterization of synthetic rate instrument hedges as a separate type of hedge. Instead, the Board believes that a synthetic rate instrument is a method for evaluating hedge effectiveness. Staff will revise the language of the preliminary views document for presentation at the Board teleconference on April 4.

The Board tentatively voted to add a section to the summary that lists additional topics scheduled to be addressed at a future point in time. The Board’s intention is to share, as early as possible, its preliminary views on how derivative transactions and hedging activities should be approached from an accounting, reporting, and disclosure perspective. Staff will draft language that delineates the topics that are scheduled to be reviewed clearly stating that guidance on all of the topics associated with derivatives will not be addressed in this PV.

The Board asked staff to further explore whether the Contradictory Information section should remain a separate topic in the PV or whether it should be folded into the discussions of each method for testing hedge effectiveness. Staff will explore different triggers that would make an otherwise effective hedge ineffective, evaluating each event in the context of the separate methods for testing hedge effectiveness to determine which ones are applicable to each method.

The Board tentatively agreed with staff’s recommendation that a complete set of disclosures not be included for each illustration (Paper 2). The Board requested that additional verbiage be added to the Purpose of the Illustration section of the illustrations to set the context for what the user will be reading. For example, instead of stating that the hedge being illustrated is effective, the Board suggested that staff describe how the hedge was actually effective. Staff will revise the illustrations to be inline with the Board’s suggestions; the revised illustrations will be presented at the April teleconference.

In the discussion of disclosures (Paper 3), the Board tentatively supported staff’s recommendation to extend the disclosure requirements outlined in GASB Technical Bulletin No. 2003-1, Disclosure Requirements for Derivatives Not Reported at Fair Value on the Statement of Net Assets, to all derivatives. The Board tentatively added a hedge’s termination as a required disclosure and affirmed that hedge ineffectiveness should be a required disclosure. The Board tentatively determined that governments do not have to disclose both the annual and life-to-date actual synthetic fixed rate; only the rate used to qualify for hedge effectiveness should be disclosed. The Board also tentatively concluded that a schedule of derivative activities should be a required disclosure.

In its discussion of swaptions (Paper 4), the Board tentatively determined that the upfront payment received by the government entity constitutes a loan that should be recognized at the inception of the transaction. This approach parallels the accounting treatment for the upfront payments received in an off-market swap, which the Board studied at the January meeting. The Board tentatively supported staff’s recommendation to bifurcate the swaption’s value between time value and a loan for its intrinsic value. In the relatively unlikely event that the option expires worthless to the counterparty, the Board tentatively determined that the loan would be reclassified to a bond premium account that would then be amortized over the life of the outstanding bonds.

Minutes of Meeting, February 16, 2006 Teleconference

The Board reviewed draft language of the Preliminary Views (PV) document, which had been updated to reflect the Board’s discussion at the February 2006 Board meeting (Paper 1a). The Board’s discussion of Chapter 2 of the PV centered on the need to include the basis for conclusions for the proposed accounting treatments. Staff will revise the language of the preliminary views document for presentation at the Board meeting on March 7.

In Chapter 2, the Board requested that Staff specifically delineate between when-issued securities that are settled net versus those in which delivery of the securities is taken. The Board asked for the insertion of language indicating that if when-issued securities meet the definition of derivatives, they must then be accounted for at fair value. Conversely, if an investor takes delivery of the when-issued securities, the subsequent accounting treatment for the securities falls outside the scope of this standard.

The Board’s discussion of Chapter 2 continued with consideration of guaranteed investment contracts (GIC). The Board determined that additional research on GICs was required so that the topic could be effectively and thoroughly deliberated. Staff recommended that the GIC topic be considered outside of the scope of the PV because of the substantive nature of the issues surrounding GICs. The Board agreed with staff’s position. Staff will develop a separate research paper for presentation at a future Board meeting that will be considered for inclusion in a potential Exposure Draft.

The Board requested the removal of the section titled Issues in This Chapter Not Addressed by the Board from Chapter 2. The Board tentatively took the position that any issues not already deliberated should not be included in the PV. Those issues will be discussed at future Board meetings through the staff’s presentation of topic-specific papers and will be considered for inclusion in a future Exposure Draft.

The Board spent additional time discussing hedge effectiveness terminology (Chapter 3), specifically the use of the phrase the same as versus the use of on or about or near when evaluating the conditions applicable to fair value hedges and cash flow hedges. The Board tentatively determined that the phrase the same as means the same date; the Board did not object to the substitution for the phrase the same as with on or about or near.

The Board indicated a tentative general consensus in support of the staff’s recommendation requiring a 90/111 range for the effectiveness test for synthetic rate instruments. The Board also determined that hedge effectiveness should be assessed at two levels: first, on an annual basis and, if necessary, second, on a life-to-date basis. If the hedge is shown to be ineffective on an annual basis, it may still qualify for hedge accounting if it is shown to be effective on a life-to-date basis. Staff will prepare revised text for the Board to consider at the March 7 meeting.

The Board requested that the Statistical Analysis section be renamed Quantitative Techniques. The Board also requested that staff re-work the section to more fully explain how regression analysis can be applied instead of supplying its definition. The modified section will be presented to the Board at the March 7 meeting.

Staff presented four potential early termination scenarios to the Board (Paper 2). The Board tentatively agreed with the staff’s recommendation that the accounting treatment for both Scenario 1 and Scenario 2 should be the same when the rate lock is liquidated on or about the date that the fixed-rate bonds are issued. In those instances, the gain or loss associated with the derivative should be deferred and amortized over the life of the swap.

With regard to Scenario 3, the Board tentatively agreed with the staff’s assertion that the acceptable length of time that can pass between the sale of a derivative and the issuance of bonds is situation specific and should be left to professional judgment. The Board cited the need for management to demonstrate positive intent as well as document its reasoning for the time delay and whether or not the delay exposed the government to interest rate risk. Of particular importance to the Board was whether or not new bonds are issued after the sale of the derivative. The Board tentatively indicated that, if new bonds are issued, the gain or loss associated with the termination of the derivative should be deferred and amortized over the life of the new bonds.

The Board agreed with the staff’s Scenario 4 recommendation that the deferral account be retained until the hedged transaction is recognized on the financial statement so that the hedged item would be shown net of the gain or loss on the hedging derivative. The approach of keeping the hedged item together with the hedging derivative provides a more complete picture of the government entity’s exposure to risk.

Minutes of Meeting, January 24-26, 2006

The Board reviewed draft language that would be included in a Preliminary Views document (Paper 1). The Board indicated general support for the content of the document and suggested specific edits. The Board discussed whether the definition of derivatives contained in FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, should be incorporated in its entirety or by reference. The Board tentatively decided to incorporate the Statement as its own, stipulating that modifications would be necessary to address certain unique requirements of the state and local government environment.

The methods for evaluating hedge effectiveness were also revisited, with focus given to the consistent critical terms method. The Board requested revisions in language to further clarify the requirements for determining hedge effectiveness. Staff will revise the language for presentation at the teleconference on February 16.

The Board indicated general consensus in support of the "new information" provision. After relabeling new information with the new term contradictory information, the Board tentatively accepted consideration of new information in the following two ways: information presented after hedge effectiveness has been established may indicate that a hedge is no longer effective and information presented after a hedge has been characterized as ineffective may indicate that the hedge has become effective. Staff will edit this section to reflect language consistent with the Board’s consensus opinion. The revised section will be presented to the Board at the February 16 teleconference.

In its discussion of early termination of derivative contracts (Paper 2), the Board did not agree with the staff’s proposal that the gain or loss on the interest rate lock described in the example illustrated should be reported as a part of investment income. The Board tentatively decided that the gain or loss related to the interest rate lock held to term completion should be recognized as a cost of borrowing over the life of the bonds as an addition to interest expense/expenditure, consistent with any other costs of issuing the bonds. Based on this discussion, the Board requested further clarification regarding staff’s definition of an early termination. Staff will present revised text to the Board at the February 16 teleconference.

The Board’s discussion of off-market swaps (Paper 3) yielded a tentative consensus with the staff’s recommendation that derivatives carrying up-front payments to the government should be reported as a hybrid instrument. The up-front payment is a borrowing that the government has committed to simultaneously upon entering into an at-the-money swap. As a loan, the liability associated with the up-front payment would be reported at its historical price.

Minutes of Meeting, January 3, 2006 Teleconference

The Board reviewed the draft language that addresses the requirements for hedge accounting. Some edits were proposed to make the text more clear; however, no significant changes other than those presented below were made to the staff proposal at this meeting. The staff will continue to work on the draft language and it will be addressed again at the January meeting.

The Board then discussed the synthetic "fixed-rate" method of assessing the effectiveness of a derivative. The Board tentatively agreed to use the fixed rate of the swap as the benchmark for measuring effectiveness. Additionally, the Board tentatively decided to change terminology in order to better describe the transaction. Synthetic fixed rate was replaced with fixed swap rate, and the term actual synthetic rate was coined to reflect the total of all swaps and hedged item payments. The Board also discussed whether the range of prescribed values should be a standard or a guideline. Because the Board was evenly divided, with one Board member absent, the Board did not reach a decision. Staff was asked to consult with that member to get his views. [Subsequently, that member expressed the view that the prescribed values should be a standard.]

The Board discussed when hedging gains and losses should be reported. The Board tentatively decided that the previous decision to recognize hedging gains and losses at the time of the early termination still stands but requested further clarity regarding what qualifies as an early termination. At the next meeting the Board will discuss the specifics of early termination.

Hedging illustrations (Paper 2 and its supplement) were also discussed. The Board discussed the issue of what a government may be hedging. For example, is the government hedging BMA (a benchmark interest rate) or is it hedging actual cash payments to bondholders? Finally, the Board discussed the commodity swap illustration. As illustrated, the cost of fuel is not depicted as being diminished by the gain on the futures contract. The possibility of presenting the cost of fuel net of the gain as well as adding a separate line item for the gain was discussed. Staff indicated that there were a number of possibilities and that a paper would be developed for the next Board meeting.

Minutes of Meeting, December 13-15, 2005

The Board studied draft language addressing the criteria for determining if a hedge exists and criteria for determining when hedge accounting should be applied. Edits were proposed to make the text more consistent with the notion that hedge accounting (when the requirements are met) is a requirement, not an option. Staff will revise the language for presentation at the teleconference on January 3.

Hedging illustrations (Paper 2 and its supplement) also were discussed. The Board considered the issue of a "synthetic fixed" interest rate. Specifically, the Board questioned whether this rate should equal the fixed rate on the swap or if the projected receipts on the swap and payments to the bondholders also need to be considered. Additionally, the Board discussed the potential for early termination of a hedge and the possibility of a large cash payment. Reasons that a swap could have a negative value were addressed. The Board discussed the idea of what a government may be hedging—for example, is the government hedging BMA (a benchmark interest rate) or is it hedging actual cash payments to bondholders? Finally, the Board discussed the commodity swap illustration. As illustrated, the cost of fuel is not depicted as being diminished by the gain on the futures contract. The possibility of showing the cost of fuel net of the gain as well as adding a separate line item for the gain was discussed. Staff indicated that there were a number of possibilities and that a paper would be developed for the January Board meeting.

Minutes of Meeting, November 21, 2005 Teleconference

The Board discussed the criteria needed for a hedge to qualify for hedge accounting. The Board also discussed when a hedge is no longer effective for hedge accounting purposes. The Board tentatively decided that staff should continue research on critical values. That research is expected to be helpful in developing criteria to determine when derivatives qualify for hedge accounting and when hedges are no longer effective.

The Board also discussed the issue of ineffectiveness. The Board tentatively decided that the ineffective portion of a derivative that qualifies for hedge accounting should be disclosed. The Board will revisit this issue after the critical values are determined.

Minutes of Meeting, November 1-3, 2005

An expert panel of financial statement users discussed issues related to derivatives, disclosures, hedges, and ineffectiveness. The panel presented ideas about what an effective hedge should be and the type of information related to derivatives that they would find most useful in their analysis. With regard to ineffectiveness, the panel discussed various methods of presentation and potential methods of calculation.

After the panel discussion, the Board discussed the project plan and contemplated the issues presented in the staff paper. The Board determined that it needed additional time to consider the recommendations of the panel. Therefore, the issues will be presented again at the November teleconference along with a revised Preliminary Views document. The staff will continue to gather information related to these topics for that meeting.

Minutes of Meeting, September 20-22, 2005

The Board continued its study of hedge criteria and tentatively decided that criteria to determine hedge effectiveness would be described in principle in the standard. Specific methods—such as regression—that could be used as criteria would be identified in the standard. However, hedges would not be required to achieve prescribed statistical or other benchmarks to be considered effective. Nonauthoritative illustrations would be provided that depict application of methods to common derivative usages.

The Board considered several methods of assessing hedge effectiveness and reached the following tentative conclusions. Under the consistent critical terms method, retesting a hedge for effectiveness would not be required. Under the regression method, the Board indicated that the regression analysis should be updated as time elapses. Although no minimum R2 statistic is expected to be established, the updated R2 statistic would be a required disclosure. There was some discussion of whether additional information should be disclosed, such as look-back periods and the presence of data smoothing, but no conclusion was reached. Under the synthetic instrument method, there would be no required metrics, such as an actual effective rate of within so many basis points of an expected fixed rate. However, the actual effective rate—either life-to-date or for the period, or both—would be a required disclosure. Under the risk reduction measure, there would be no required metric, but the specific method used and the updated metric would be a required disclosure. Finally, staff indicated that the dollar offset method required more research. Throughout this discussion, staff indicated that a "new information" caveat could be applied to the methods. However, the Board did not reach any conclusions regarding the role that "new information" would have on hedge effectiveness considerations.

The Board agreed to organize an expert panel at the November meeting. This panel will be able to provide further information about determining specific criteria for an effective hedge and what information is valuable to users, as well as any specific concerns they have about derivatives.

Minutes of Meeting, August 9-11, 2005

Scott Krantz from the Southern Nevada Water Authority (SNWA) led an educational discussion on commodity swaps. Mr. Krantz described the objective of SNWA’s hedging program and outlined the various methods for assessing its effectiveness. He detailed the differences between cash settlement of a commodity hedge compared to physical delivery. Mr. Krantz also described the various layers of swaps his authority uses to hedge price risk. No decisions were called for.

Minutes of Meeting, June 21-23, 2005

Before discussion of the staff papers, staff described their approach to consideration of FASB and IASB literature. The Board indicated that staff’s approach is consistent with the strategic plan and the rules of procedure. Staff also updated the Board on the implications of the "normal purchase/normal sales" exception. Using the FASB definition of derivatives, forward contracts for the purchase of sales of commodities that cannot be cash-settled are not derivatives and are not within the scope of the project. There was a discussion of commodity contracts that can be cash-settled. Staff indicated that a better understanding of business practices is necessary and that a Board educational session at the next meeting would be appropriate. The Board agreed with this recommendation.

The Board focused its formal discussion on two topics. The first was a discussion of what is hedgeable. During this discussion, the Board tentatively decided that firm commitments and forecasted transactions are items that may be hedged, provided they meet the criteria (to be developed) for hedge accounting. The Board also tentatively decided that transactions solely within a government—interfund transactions—may not be hedged. However, transactions between a primary government and a discretely presented component unit would be hedgeable. Risks associated with only a portion of cash flows or fair values of a financial asset or liability (or potential financial asset or liability) would be hedgeable, provided that effectiveness could be measured. On the other hand, staff will do further research on comparable treatment of risks associated with nonfinancial assets and liabilities. Groups of similar assets, liabilities, firm commitments, and forecasted transactions would be hedgeable. The Board agreed that staff needs to do further research on whether or not to allow hedge accounting to be applied to hedges of a net position and foreign currency risk.

The second paper focused on the termination of hedge accounting in circumstances other than when the expected payments have been made or a derivative’s term has expired. The Board tentatively decided that in all cases, the balance in the deferral account would immediately be recognized as gain or loss on the change statement. This would occur as soon as the hedge accounting relationship is dissolved. The Board also indicated that the format of the illustration was satisfactory.

As noted above, the August meeting is expected to be an educational session that will prepare the Board for establishing the criteria that must be met to qualify for hedge accounting.

Minutes of Meeting, May 17–19, 2005

The Board continued its discussion of derivatives and hedging. After considering the effects of measuring derivatives at fair value on the statement of net assets, the Board tentatively decided that there needs to be some form of "special accounting" for derivatives. The special accounting treatments considered by the Board include methods that mitigate the effects of fair value gains and losses on the change statement, either by measuring a derivative at its historical price in certain instances (the context-based method) or by reporting hedging gains and losses as deferrals on the statement of net assets (the fair value with hedge accounting method). The Board then tentatively decided that the fair value with hedge accounting method (1) is the most desirable special accounting method and (2) should also be used for reporting derivatives in governmental funds. These tentative decisions will be further refined as the Board considers additional topics set forth in the project work plan, including calibrating the criteria for applying hedge accounting.

At the next meeting, the Board will discuss firm commitments and forecasted transactions. Additional topics may be presented for the Board’s consideration.

Minutes of Meeting, April 5–7, 2005

The Board continued its discussion of the Derivatives and Hedging project. The Board tentatively decided that historical price is not a viable method of accounting for derivatives; that method will no longer be considered as a potential method in future deliberations. The Board tentatively agreed to remove the matched-book issue from the project because of the unique issues that need to be addressed for that subject would further delay the project. On the other hand, the Board tentatively reconfirmed that the scope of the project includes derivative disclosures.

A detailed project plan was presented. It was tentatively decided at this time that a Preliminary Views document would be included in the project’s technical plan. For the May meeting, the Board will discuss the remaining three methods: context-based, hedge accounting, and fair value without modification.

Minutes of Meeting, February 22–24, 2005

Staff briefed the Board on the results of their interviews regarding reporting ineffectiveness as gains and losses, and potential hedge criteria. The Board then discussed the two papers presented by the staff. The first paper followed up the January meeting discussion of reporting ineffectiveness by providing additional reporting examples, including recapture. The second paper presented a first draft of a staff proposal for identifying derivatives that would qualify for either the context-based approach or hedge accounting. The Board discussion focused more on the objective of the project than on the qualifying conditions and criteria presented in the paper; therefore, no decisions were reached on the staff proposal. The Board then discussed the general direction of the project. For the April meeting, the project team will present a review of the scope of the project, tentative decisions already made, the issues identified to date with regard to the two basic alternatives under consideration (context-based method and hedge accounting), and a detailed project plan for addressing remaining issues.

Minutes of Meeting, January 11–13, 2005

The Board discussed a comprehensive hedge accounting illustration. This illustration included the process of constructing and analyzing a three-year swap. Issues of ineffectiveness, over- and underhedging, and recapture were also discussed. No decisions were made at this meeting. At the February meeting, the Board will resume discussions of the context-based method.

Derivatives and Hedging—Major Tentative Decisions

Statement No. 53, Accounting and Financial Reporting for Derivative Instruments, was approved in June 2008.

Derivatives and Hedging—Relevant Links