FASB Foreign Currency Hedges Designation of a Foreign-Currency-Denominated Debt Instrument as both the Hedging Instrument in a Net Investment Hedge and the Hedged Item in a Fair Value Hedge

FASB: Foreign Currency Hedges: Designation of a Foreign-Currency-Denominated Debt Instrument as both the Hedging Instrument in a Net Investment Hedge and the Hedged Item in a Fair Value Hedge

Derivatives Implementation Group

Statement 133 Implementation Issue No. H11

Title: Foreign Currency Hedges: Designation of a Foreign-Currency-Denominated Debt Instrument as both the Hedging Instrument in a Net Investment Hedge and the Hedged Item in a Fair Value Hedge
Paragraph references: 42, 423
Date cleared by Board: June 28, 2000

QUESTION

May an entity designate a foreign-currency-denominated debt instrument as the hedging instrument in a net investment hedge and also designate that debt instrument as the hedged item in a fair value hedge of interest rate risk?

BACKGROUND

A U.S. parent company (Parent A) with a U.S. dollar functional currency has a German subsidiary that has the Euro as its functional currency. On January 1, 2001, Parent A issues a five-year, fixed-rate Euro-denominated debt instrument and designates that Euro-denominated debt instrument as a hedge of its net investment in the German subsidiary. On the same date, Parent A enters into a five-year Euro-denominated receive-fixed, pay-Euribor-interest rate swap. Parent A designates the interest rate swap as a hedge of the foreign-currency-denominated fair value of the fixed-rate Euro-denominated debt instrument attributable to changes in Euribor interest rates, which is considered the benchmark interest rate for a hedge of the Euro-denominated fair value of that instrument.

RESPONSE

Yes. A foreign-currency-denominated debt instrument that is designated as the hedging instrument in a net investment hedge may also be designated as the hedged item in a fair value hedge of interest rate risk. The two hedging relationships address separate risk types that are permitted to be hedged individually under Statement 133. Paragraph 42 of Statement 133 permits a nonderivative financial instrument that gives rise to a foreign currency transaction gain or loss under Statement 52 to be designated as a hedge of the foreign currency exposure of a net investment in a foreign operation. In addition, paragraph 21(f)(2) of Statement 133 specifically permits fair value hedge accounting for hedges of interest rate risk, which encompasses the notion of using an interest-rate derivative to hedge the changes in a debt instrument's foreign-currency-denominated fair value due to changes in the designated benchmark interest rate. Thus, in the example described in the Background section, Parent A may designate the Euro-denominated debt instrument as a hedge of its net investment in the German subsidiary and also as the hedged item in a fair value hedge of the debt instrument's foreign-currency-denominated fair value attributable to changes in the designated benchmark interest rate.

As a result of applying fair value hedge accounting, the debt's carrying amount will be adjusted to reflect changes in its foreign-currency-denominated fair value attributable to interest rate risk. The notional amount of the debt that is designated as the hedging instrument in the net investment hedge will change over time such that it may not match the notional amount of the hedged net investment. Consistent with the guidance in Statement 133 Implementation Issue No. H8, "Measuring the Amount of Ineffectiveness in a Net Investment Hedge," regarding the use of derivatives in hedging the net investment, if the notional amount of the hedging instrument (the foreign-currency-denominated debt instrument) does not match the notional amount of the hedged net investment, the amount of ineffectiveness to be recognized in earnings must be measured as the difference between the actual foreign currency transaction gain or loss on the hedging foreign-currency-denominated debt instrument and the foreign currency transaction gain or loss on a "hypothetical" hedging nonderivative instrument (the foreign-currency-denominated debt instrument) that has a notional amount that matches the hedged net investment.

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.