Derivatives Implementation Group

Statement 133 Implementation Issue No. H10

QUESTION

Does Statement 133 permit a combination of a derivative and a cash instrument to be designated as a single hedging instrument in a hedge of a net investment in a foreign operation?

For example, a parent company that has the U.S. dollar as its functional and reporting currency has a net investment in a Japanese yen-functional-currency subsidiary. The parent borrows in Deutsche marks on a fixed-rate basis and simultaneously enters into a receive-Deutsche mark, pay-Japanese yen currency swap (for all interest and principal payments) to synthetically convert the borrowing into a yen-denominated borrowing. Can the parent company in the above example designate the Deutsche mark-denominated borrowing and the currency swap in combination as a hedging instrument for its net investment in the Japanese yen-functional-currency subsidiary?

RESPONSE

No. A derivative and a cash instrument may not be designated in combination as a single hedging instrument in a hedge of a net investment in a foreign operation. Although Statement 133 permits nonderivative instruments to be designated as net investment hedges, it prohibits considering a separate derivative and a cash instrument as a single synthetic instrument for accounting purposes. For example, a debt instrument denominated in the investor's functional currency and a cross-currency interest rate swap cannot be accounted for as synthetically created foreign-currency-denominated debt to be designated as a hedge of the entity's net investment in a foreign operation. An approach that would involve measuring a derivative and a cash instrument as a single unit at the current spot rate (which is used in the translation of the hedged net investment) violates the requirements of FASB Statement No. 52, Foreign Currency Translation, for translation of foreign-currency-denominated borrowings at the spot rate relevant to the currency of the borrowing. It also violates the requirements of Statement 133 for measurement of all derivatives at fair value. Accordingly, in the example in the question section, combining the Deutsche mark-denominated borrowing and the currency swap for designation as a single hedging instrument-a yen-denominated borrowing-in a net investment hedge is not permitted.

In contrast with the above example, an entity could designate a foreign currency derivative and a foreign-currency-denominated cash instrument individually as hedging different portions of its net investment in a foreign operation provided the derivative and the cash instrument each individually qualified as a hedging instrument. For example, a Japanese yen-U.S. dollar forward contract and a Japanese yen-denominated cash instrument could each be designated as the hedging instrument in a hedge of different portions of the net investment in a Japanese yen-functional-currency subsidiary (that is, two separate hedging relationships would be designated).

The above response has been authored by the FASB staff and represents the staff's views, although the Board has discussed the above response at a public meeting and chosen not to object to dissemination of that response. Official positions of the FASB are determined only after extensive due process and deliberation.