Bending to bankers' complaints, the Financial Accounting Standards Board has delayed a new derivatives accounting rule and backed away from one of its more controversial requirements.
The accounting board Wednesday pushed back the deadline for compliance to July 1, 1998, from Dec. 15, 1997. The agency also disclosed that the proposed rule has been adjusted in order to reduce the volatility in earnings that could occur due to temporary gains or losses in the market value of derivatives contracts.
"I think the board really heard from constituents in the financial community loudly and clearly," said Gerhard G. Mueller, a member of the accounting board. The board, he said, "is moving in their direction as far as it can."
Derivatives are financial contracts whose values are based on underlying assets or indexes. Banks commonly use them to guard against changes in interest rates, although the contracts can also be written to make leveraged bets on changes interest rates, stock prices, or other assets.
The instruments have come under scrutiny from regulators and accountants in the wake of huge, unexpected losses by municipalities such as California's Orange County and other users that didn't fully understand the risks of the instruments they bought.
To help investors and regulators gauge the financial risks of these tricky instruments, the accounting board proposed last year that all users assess the fair value of their derivatives and report any gains or losses in their quarterly income statements.
Derivatives users protested immediately, with the loudest gripes coming from bankers-who control about one-third of the $60 trillion in notional value of derivatives contracts outstanding.
In meetings last November at the accounting board's headquarters in Norwalk, Conn., executives of corporations ranging from BankAmerica Corp. to the Coca-Cola Co. argued that reporting gains or losses every quarter on contracts that often last several years could cause earnings to become quite volatile. And that volatility, they said, would scare investors.
In light of the opposition, the board began revising its proposals.
Perhaps the most significant revision enables banks to separate the kinds of risks they are hedging against. If a bank enters into an agreement to swap a fixed rate of interest for a floating rate, the new rules would allow the bank to account for the risk of interest rate change separately from other risks, such as credit or legal risk.
It works like this: A bank might hedge a $100 note with a derivative whose fair market value is $2. If after three months, the note's value declines to $90, FASB's original proposal had the bank report an $8 loss in its income statement. Because many banks hold billions of dollars worth of derivatives, they feared quarterly earnings would see-saw if interest rates start moving again.
But under the new proposal, banks would have to report losses only for items the derivative was meant to hedge. So if only $2 of the $10 loss were due to changes in interest rates, the accounting board would allow the bank to report a loss of only $2 at the end of the quarter because of the $2 derivative.
"This should go a long way toward addressing banks' concerns about volatility," Mr. Mueller said.
"It's a major improvement," said Michael S. Joseph, partner at Ernst & Young LLP. The only problem, Mr. Joseph said, is that banks lack the technology to separate their risks the way the accounting board envisions.
Recognizing the technology gap, the board has agreed to delay the implementation date of its proposals to the summer of 1998. And the many banks that don't begin their fiscal years until Jan. 1 wouldn't have to comply until 1999.
The board is working toward putting together final rules by the end of June.