On the Horizon

Hedging: Last-of-Layer Method


In early 2020, the FASB expects to issue a proposed Accounting Standards Update (ASU) that would improve GAAP by expanding the “last-of-layer” hedging method.

In 2017, the FASB issued a new hedging standard to better align the economic results of risk management activities with hedge accounting. The new standard increased transparency around how the results of hedging activities are presented, both on the face of the financial statements and in the footnotes, for investors and analysts.
Since issuing the [hedging] standard, stakeholders have told the FASB that the ability to hedge a single layer is useful, but not as helpful as it could be.

One of the major provisions of that standard was the addition of the last-of-layer hedging method. For a closed portfolio of fixed-rate prepayable financial assets, such as mortgages, the last-of-layer method allows a company to hedge its exposure to fair value changes due to changes in interest rates for a portion of the portfolio that is not expected to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. As a result, prepayment risk is not incorporated into the measurement of the hedged item.

Since issuing the standard, stakeholders have told the FASB that the ability to hedge a single layer is useful, but not as helpful as it could be. These stakeholders asked if the single-layer model could be expanded to hedge multiple layers of a single closed portfolio.

In response to that feedback, the FASB conducted outreach with approximately 30 stakeholders, including financial institutions, hedging consultants, and practitioners. Based on this and other input, the FASB decided to add a project to its technical agenda that would expand the model to include multiple layers.

Stakeholders are encouraged to review and provide comments on the proposal when it is issued next year.