FASB Fair Value Hedges Basing the Expectation of Highly Effective Offset on a Shorter Period Than the Life of the Derivative

FASB: Fair Value Hedges: Basing the Expectation of Highly Effective Offset on a Shorter Period Than the Life of the Derivative

Derivatives Implementation Group

Statement 133 Implementation Issue No. F5

Title: Fair Value Hedges: Basing the Expectation of Highly Effective Offset on a Shorter Period Than the Life of the Derivative
Paragraph references: 20(a), 20(b), 386-390
Date cleared by Board: November 23, 1999

QUESTION

If a derivative with a five-year term is designated as the hedging instrument in a fair value hedge of a financial asset that also has a five-year term, may an entity base its expectation that the hedging relationship will be highly effective in achieving offsetting changes in fair value for the risk being hedged by considering the possible changes in value occurring only over a shorter period than the life of the derivative, for example, over only the first three months of the derivative's five-year life?

BACKGROUND

To qualify for fair value hedge accounting, Statement 133 requires that an entity must expect the hedging relationship to be highly effective in achieving offsetting changes in fair value for the risk being hedged. The Statement does not specify the method to be used in assessing the hedge's effectiveness in achieving offsetting changes in fair values nor does it specify how the expectation of highly effective offset should be determined. However, the Statement requires that the assessment of effectiveness be consistent with the risk management strategy documented for that particular hedging relationship. Furthermore, an assessment of effectiveness is required whenever financial statements or earnings are reported and at least every three months.

RESPONSE

Yes. In documenting its risk management strategy for a fair value hedge, an entity may specify an intent to consider the possible changes (that is, not limited to the likely or expected changes) in value of the hedging derivative and the hedged item only over a shorter period than the derivative's remaining life in formulating its expectation that the hedging relationship will be highly effective in achieving offsetting changes in fair value for the risk being hedged. The entity does not need to contemplate the offsetting effect for the entire term of the hedging instrument.

Thus, in the example cited above involving a five-year derivative hedging a five-year financial asset in a fair value hedge, an entity may specify, in documenting its risk management strategy, that every three months (a) it will assess the effectiveness of the existing hedging relationship for the past three-month period and (b) it intends to consider possible changes in value of the hedging derivative and the hedged item over the next three months in deciding whether it has an expectation that the hedging relationship will continue to be highly effective at achieving offsetting changes in fair value.

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.