Complexity of the former rule set forced the majority of corporates to avoid financial hedges
The new standards simplify the accounting rules around hedging
Expected to cause more companies to start hedging commodities or increase the volume of their hedges
Come into effect in 2018/19
Aaron Cowan, executive director and global leader of corporate accounting advisory services at Chatham Financial, a global risk management advisory firm, said that while the new standard will provide “a lot of opportunities” for companies, its biggest effect is likely to be on the way that companies deal with commodities risk.
“We’ve seen historically that the punitive guidance in the past was a stumbling block to corporate hedging in the commodities arena,” he said. “We believe a lot more companies will start hedging commodities or increase the amount they were hedging because of the new rules.”
Under the previous FASB hedge accounting standard, companies had to consider the total cash flows associated with the hedged purchases of commodities. That posed a challenge for companies dealing with commodities because the cost can include the cost of fabricating and shipping the commodity. But changes in those components of the cost aren’t reflected in the financial derivatives used to hedge commodity costs.
Cowan compared that to a company hedging interest rates, which can borrow at a rate based on Libor and then hedge that Libor exposure. “Now commodities [hedging] is able to move into that realm, where you can focus on a specific component of the price,” he said.
To date, companies have been much less likely to use hedge accounting for commodities hedging. A benchmark study of the filings of more than 1,500 public companies that Chatham updated last year showed that while 80% of companies that hedged their interest rate exposures applied hedge accounting, as did 90% of those with cash flow currency hedging programs, only 45% of companies that hedged commodities exposures used hedge accounting.
With the arrival of the new standard, companies that have commodities exposures but “let the accounting tail wag the dog may start hedging commodities for the first time,” Cowan said. “Companies that are hedging but in a small way, because they don’t get hedge accounting, will likely increase the hedging they do.