After seven years of debate and 140 public hearings, the Financial Accounting Standards Board said Monday that it will require companies to report the market value of derivatives on financial statements.
Banks and investment firms that sell and use the financial contracts have protested that the rule would distort earnings statements. But FASB, announcing the rule at a press briefing, said that without it, U.S. companies could hide derivatives losses, causing investors to lose confidence in the market and precipitating crises similar to those in Indonesia and Thailand.
"At the end of the day, we needed to focus on investors and creditors, and that is what we have done with this rule," said accounting standards board Chairman Edmund L. Jenkins.
Derivatives are contracts intended to help buyers hedge financial risks. Their values fluctuate depending on changes in interest rates, currency rates, and other underlying indexes.
The standards board began its effort in 1991, mainly as a research project. But the process was kicked into high gear in 1994 after soured derivatives contracts sank Orange County, Calif., into bankruptcy, prompting calls for action from Congress.
The rule is effective for fiscal years beginning after June 15, 1999, and requires that income statements include gains and losses from derivatives. The rule exempts derivatives used to hedge other securities, provided they are "highly effective" in offsetting changes in the value of the hedged instrument.
Industry officials criticized the FASB rule, arguing it will cause earnings to fluctuate wildly because most bank derivatives will not qualify for the hedging exemption.
"This will have a tendency to distort not only earnings but the impact of derivatives," said John J. Dolan, chief financial officer for First Commonwealth Financial Corp., a $1 billion-asset institution in Indiana, Pa.
Donna J. Fisher, director of tax and accounting at the American Bankers Association, said many banks hedge an entire portfolio of securities, rather than specific instruments. Because banks cannot directly link a specific security to a specific derivative, they may not use the hedge exemption, she said. As a result, the FASB rule will force banks to "mislead investors" by overstating the financial effects of derivatives, she said.
A spokesman for the International Swaps and Derivatives Association also criticized the rule, saying it would discourage companies from hedging risk.
At the press briefing, Mr. Jenkins defended the rule, saying it "should not get in the way too much" of those who legitimately want to hedge against potential losses. But he said the accounting standards board could not yield to banking industry demands that all derivatives used for hedging be exempted.
"The bottom line is that the use of derivatives to hedge a portfolio of dissimilar securities is inappropriate," he said.
Ms. Fisher said the bankers association would continue to support bills by Rep. Richard H. Baker, R-La., and Sen. Lauch Faircloth, R-N.C. to reform the accounting standards board.
The Baker bill would require the SEC to approve accounting rules before they take effect. The Faircloth bill would allow regulators to exempt banks from accounting rules that distort earnings or impair risk-management efforts.
Mr. Jenkins criticized both bills, warning that they would politicize the drafting of accounting rules, the very practice that worsened the 1980s thrift crisis. "This would be a mistake and not in the best interest of investors or the capital markets," he said.
The accounting standards board formally voted Thursday but did not release the decision until Monday. The text of the rule will not be available for at least two weeks.