Bankers at a hearing in Norwalk, Conn., have dug in for a last-ditch stand against a controversial derivatives reporting rule.
At a four-day hearing of the Financial Accounting Standards Board, bankers are arguing that a proposed accounting requirement - which FASB intends to implement this summer in hopes of providing investors with a more accurate picture of corporations' fiscal condition - would distort earnings statements and ultimately discourage sound risk management practices.
The FASB proposal to require companies to report fluctuations in the value of their derivatives holdings would "create income statement volatility that doesn't really reflect the underlying economics," said Steven Dixon, a senior vice president at BankAmerica Corp. Mr. Dixon said under FASB's proposal, his bank's earnings could fluctuate as much as 10% per quarter if interest rates shift by only 50 basis points.
Members of the standards board said they may compromise on some details, but they do not plan to retreat.
"We hear the arguments about earnings volatility loud and clear, and we're listening. We want to level the volatility out, and we don't want to affect how companies do business because we're not a corporate cop," said one board member, who asked not to be identified by name. "But we have to do something. The derivatives market has grown, and balance sheets ought to reflect that."
Derivatives are contracts whose values are tied to that of an index or asset, such as interest rates, commodities, or foreign currency exchange rates. According to a recent survey by the International Swaps and Derivatives Association, new derivatives business grew 20% in the first half.
The notional value of derivatives contracts held by banks and other corporations totals at least $19 trillion.
Derivatives are supposed to be used to hedge business risks, but they have caused some well-publicized losses to banks, corporations, and municipalities that failed to anticipate spikes in interest rates and other indexes.
FASB wants users to mark their derivatives to market and report any changes in value in their quarterly income statements when the derivative is greater than the asset being hedged.
For example, a bank wanting to protect $100 can buy $125 in hedges. Bankers say they do this for risk management purposes - anticipating that the cost of keeping $100 may go up.
But accountants say it is impossible to distinguish between risk management and speculation, which can cause heavy losses. To ensure that a hedge is really just a hedge, FASB's proposals require that banks mark the extra $25 to market and include that value in their quarterly income statement.
Because values of derivatives can be quite volatile, BankAmerica and other banks are worried that this will translate into unpredictable earnings statements. Mr. Dixon said his bank estimates a $2 billion mismatch between hedges and underlying assets.
But FASB board members seemed unmoved by the chorus of objectors.
"Mark to market is the direction we're moving in," insisted FASB vice chairman James Leisenring.
Though bankers oppose this stance, investors embrace it. Tony Sondhi of the Association for Investment Management and Research said more comprehensive disclosure of derivatives use would help better assess how companies manage assets and handle changes in market conditions.
But Patrick Montgomery, a lobbyist for the Treasury Management Association, said that because many companies now discuss derivatives and risk management strategies in their annual reports, the new rules wouldn't provide much new material to investors.