Derivatives Implementation Group

Statement 133 Implementation Issue No. E10

QUESTIONS

Question 1A

May the shortcut method be applied to fair value hedges of a proportion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the portion of the asset or liability being hedged, and all other criteria for applying the shortcut method are satisfied?

Question 1B

May the shortcut method similarly be applied to cash flow hedges of the interest payments on only a portion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the principal amount of the portion of the asset or liability on which the hedged interest payments are based, and all other criteria for applying the shortcut method are satisfied?

Question 2A

May the shortcut method be applied to fair value hedges of portfolios (or proportions thereof) of similar interest-bearing assets or liabilities if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the notional amount of the aggregate portfolio? How should the other criteria in paragraph 68 be applied when the hedged item is a portfolio of similar assets or liabilities?

Question 2B

May the shortcut method be applied to a cash flow hedge in which the hedged forecasted transaction is a group of individual transactions if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the notional amount of the aggregate group that comprises the hedged transaction? How should the other criteria in paragraph 68 be applied when the hedged forecasted transaction is a group of individual transactions (such as the interest payments on several interest-bearing assets or liabilities)?

BACKGROUND

The criteria for the shortcut method do not determine which hedging relationships qualify for hedge accounting; rather, those criteria determine which hedging relationships qualify for a "shortcut" version of hedge accounting that does not immediately recognize hedge ineffectiveness.

Paragraph 68 of Statement 133 identifies criteria that an entity must satisfy in order to assume no ineffectiveness in a hedging relationship (the shortcut method). The criterion in paragraph 68(a) is that "[t]he notional amount of the swap matches the principal amount of the interest-bearing asset or liability." Some believe it is unclear whether that criterion can be satisfied for hedges of a designated proportion of the contractual principal or hedges of portfolios of similar interest-bearing assets or liabilities.

For example, an entity that issues $100 million of fixed-rate debt may wish to hedge 50% of its fair value exposure to interest rate risk, as permitted by paragraph 21(a)(2) of Statement 133. To accomplish that, the entity enters into an interest rate swap with a notional amount of $50 million. Assuming all other criteria for applying the shortcut method are met, it is unclear whether the hedging relationship meets the requirement of paragraph 68(a) that the notional amount of the swap must match the principal amount of the interest-bearing liability.

Similarly, if the $100 million of fixed-rate debt were issued in increments of $1,000 individual bonds, the entity may wish to aggregate 50,000 of those individual bonds as a portfolio to equal the notional amount of the swap, as permitted by paragraph 21(a)(1) of Statement 133 (for the purposes of this example, it is assumed that the hedge satisfies the portfolio requirements of paragraph 21(a)(1)). Some believe it is unclear whether the hedging relationship meets the requirement of paragraph 68(a) that the notional amount of the swap must match the principal amount of the interest-bearing liability and how the other criteria in paragraph 68 should be applied when the hedged item is a portfolio of similar assets or liabilities.

RESPONSE

Question 1A

Yes. Assuming all other criteria for applying the shortcut method are satisfied, the shortcut method may be applied to fair value hedges of a proportion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the portion of the asset or liability being hedged. In the example in the background section, the paragraph 68(a) criterion is satisfied because the entity has designated as a fair value hedge 50% of the contractual principal amount as the hedged item and has entered into an interest rate swap with a notional amount that matches the hedged principal amount.

Question 1B

Yes. Assuming all other criteria for applying the shortcut method are satisfied, the shortcut method can be applied to cash flow hedges of the interest payments on only a portion of the principal amount of the interest-bearing asset or liability if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the principal amount of the portion of the asset or liability on which the hedged interest payments are based.

Question 2A

Yes, provided that all other criteria for applying the shortcut method are satisfied. However, a restrictive interaction exists between the requirements for portfolio hedging in paragraph 21(a)(2) and the criteria for the shortcut method in paragraph 68, thereby making it more difficult to qualify for the shortcut method. The shortcut method may be applied for fair value hedges of portfolios (or proportions thereof) of similar interest-bearing assets or liabilities if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the aggregate notional amount of the hedged item (whether it is all or a proportion of the total portfolio), and the remaining criteria for the shortcut method are met with respect to the interest rate swap and the individual assets or liabilities in the portfolio. That is, in addition to meeting the requirements of paragraph 21(a)(2) for portfolio hedging, each individual asset or liability in the portfolio must meet the criteria for the shortcut method in the following paragraphs:

• Paragraph 68(d) - that the interest-bearing asset or liability is not prepayable (as amended by FASB Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities)

   

• Paragraph 68(e) - that any other terms in the interest-bearing asset or liability are typical of those instruments and do not invalidate the assumption of no ineffectiveness

   

• Paragraph 68(f) - that the expiration date of the swap matches the maturity date of the asset or liability.

The requirements of paragraph 21(a)(1) ensure that the individual items in a portfolio share the same risk exposure and have fair value changes attributable to the hedged risk that are expected to respond in a generally proportionate manner to the overall fair value changes of the entire portfolio. That requirement restricts the types of portfolios that can qualify for portfolio hedging; however, it also permits the existence of a certain amount of ineffectiveness in portfolios that do qualify. As a result, the assumption of no ineffectiveness required for the shortcut method generally would be inappropriate for portfolio hedges of similar assets or liabilities that are not also nearly identical (except for their notional amounts). Therefore, application of the shortcut method to portfolios that meet the requirements of paragraph 21(a)(1) is appropriate only if the assets or liabilities in the portfolio meet the same stringent criteria in paragraphs 68(d), 68(e), and 68(f) as required for hedges of individual assets and liabilities. Thus, portfolio hedging cannot be used to circumvent the application of the criteria in paragraph 68 to the hedge of an individual interest-bearing asset or liability. A portfolio of interest-bearing assets or interest-bearing liabilities cannot qualify for the shortcut method if it contains an interest-bearing asset or liability that individually cannot qualify for the shortcut method.

Question 2B

Yes, provided that all other criteria for applying the shortcut method are satisfied. For a cash flow hedge in which the hedged forecasted transaction is a group of individual transactions (as permitted by paragraph 29(a)), the shortcut method may be applied if the notional amount of the interest rate swap designated as the hedging instrument (discussed in paragraph 68(a)) matches the notional amount of the aggregate group of hedged transactions and the remaining criteria for the shortcut method are met with respect to the interest rate swap and the individual transactions that comprise the group. For example, the interest rate repricing dates for the variable-rate assets or liabilities whose interest payments are included in the group of forecasted transactions must match (that is, be exactly the same as) the reset dates for the interest rate swap.

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.