WASHINGTON--The Financial Accounting Standards Board expects to release draft accounting standards early next year for hedging transactions, some of which include municipal derivatives.

"The objective is to improve and extend accounting standards with regard to hedging and other risk management activities," said Halsey Bullen, a staff member to the board and a consultant to the hedging standards project.

The board is a private standard-setting organization whose standards are nearly always adopted by the financial community, Bullen said.

The project aims to set standards for determining what constitutes hedging transactions.

This is important because financial institutions that engage in hedging transactions can defer income gains and losses rather than having to recognize them quarterly or annually.

During the two years the project has been underway, the board has reached some conclusions, Bullen said.

The board has, in effect, defined hedging as an activity that reduces an entity's risk.

In addition, the board decided that determinations of whether risk exists and whether a transaction reduces risk should be made in the context of the entire financial institution and not just the individual transaction.

The board also concluded that hedging accounting should be permitted for certain kinds of transactions as long as: the existence of the hedge has been designated; there is a clear pricing relationship between the hedge and the item to be hedged; and what is being hedged is the risk from an existing asset or liability or a firm commitment arising from a contract, Bullen said.

The board is still wrestling with how to treat an "anticipated," or "forecasted," transaction.

An example of this kind of transaction would be a futures contract on Treasury bonds that is intended to hedge the future purchase of a municipal bond issue, Bullen said. Forward transactions are not included in this category, Bullen said, because while they involve future events they are based on contractual commitments

The board began working on the hedging project because standards issued by FASB years ago for foreign currency and futures transactions were inconsistent in some cases, and did not cover hedging products that have been developed since then.

One inconsistency, Bullen said, is that the standards for futures transactions, which were issued in 1984, cover "anticipated" transactions, but the standards for foreign currency transactions -- issued in 1981 -- do not.

Some of the derivatives products not covered by existing standards include interest rate swaps in the bond and equity markets, he said.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.