FASB Foreign Currency Hedges Designation of an Intercompany Loan or Other Payable as the Hedging Instrument in a Fair Value Hedge of an Unrecognized Firm Commitment

FASB: Foreign Currency Hedges: Designation of an Intercompany Loan or Other Payable as the Hedging Instrument in a Fair Value Hedge of an Unrecognized Firm Commitment

Derivatives Implementation Group

Statement 133 Implementation Issue No. H12

Title: Foreign Currency Hedges: Designation of an Intercompany Loan or Other Payable as the Hedging Instrument in a Fair Value Hedge of an Unrecognized Firm Commitment
Paragraph references: 36, 37, 487
Date cleared by Board: June 28, 2000
(Revised September 25, 2000)

QUESTION

May an entity designate an intercompany loan or other payable as the hedging instrument in a foreign currency fair value hedge of an unrecognized firm commitment and qualify for hedge accounting in the consolidated financial statements if, consistent with the requirement of paragraph 36, the member of the consolidated entity that is the counterparty to the intercompany loan has entered into a third-party contract that offsets the foreign exchange exposure of that entity's intercompany loan?

BACKGROUND

A parent company (Parent A) with the U.S. dollar as both its functional currency and reporting currency has a subsidiary with a Euro functional currency (Subsidiary B). Subsidiary B enters into an unrecognized firm commitment with a third party that will result in Japanese yen cash inflows. Concurrent with Subsidiary B entering into the firmly committed contract, Parent A extends a loan to Subsidiary B denominated in yen, which is funded by a third-party, yen-denominated borrowing by Parent A. Subsidiary B wishes to designate its yen-denominated intercompany loan payable as the hedging instrument in consolidated financial statements in a fair value hedge of foreign currency exposure related to its yen-denominated unrecognized firm commitment to a third party.

In accordance with paragraph 15 of FASB Statement No. 52, Foreign Currency Translation, at each balance sheet date, Subsidiary B's yen-denominated intercompany loan payable would be remeasured from the foreign currency (yen) into Subsidiary B's functional currency (Euro) at the current Euro/yen spot rate. Similarly, Parent A's intercompany yen-denominated receivable and its third-party yen-denominated loan payable are remeasured from the foreign currency (yen) in to Parent A's functional currency (U.S. dollar) at the current U.S. dollar/yen spot rate. The transaction gains or losses that are generated from remeasurement into functional currency are recorded in net income. If Subsidiary B designates its yen-denominated intercompany loan payable as the hedging instrument in consolidated financial statements, the transaction gains and losses related to the intercompany loan payable would offset the change in fair value of the firm commitment attributable to changes in foreign exchange rates in the consolidated income statement.

Paragraph 36 of Statement 133 states, in part:

     A foreign currency derivative instrument that has been entered into with another member of a consolidated group can be a hedging instrument in a fair value hedge or in a cash flow hedge of a recognized foreign-currency-denominated asset or liability or in a net investment hedge in the consolidated financial statements only if that other member has entered into an offsetting contract with an unrelated third party to hedge the exposure it acquired from issuing the derivative instrument to the affiliate that initiated the hedge.

Paragraph 37 of Statement 133 states, in part:

     A derivative instrument or a nonderivative financial instrument that may give rise to a foreign currency transaction gain or loss under Statement 52 can be designated as hedging changes in the fair value of an unrecognized firm commitment, or a specific portion thereof, attributable to foreign currency exchange rates. [Emphasis added.]

RESPONSE

Yes. An entity may designate an intercompany loan or other payable as the hedging instrument in a foreign currency fair value hedge of an unrecognized firm commitment and qualify for hedge accounting in the consolidated financial statements. That designation is consistent with the ability under paragraph 37 of Statement 133 to designate nonderivative instruments as hedging instruments in foreign currency fair value hedges of firm commitments. However, hedge accounting in the consolidated financial statements may only be applied if the member of the consolidated entity that is the counterparty to the intercompany loan has entered into a third-party contract that offsets the foreign exchange exposure of that entity's intercompany loan receivable. That is, the requirement in paragraph 36 that an intercompany derivative designated as a hedging instrument in a foreign currency fair value hedge be offset by a third-party contract would also apply to intercompany nonderivative instruments designated as hedging instruments. In order to remain consistent with the notion that the intercompany contract is simply a conduit for the third-party exposure, an intercompany loan designated as a hedging instrument must be offset by a third-party loan (that is, it may not be offset by a derivative contract). Hedge accounting may be applied in consolidation only to those gains and losses occurring during the period that the offsetting third-party loan is in place.

In the example described in the Background section, Subsidiary B's yen-denominated intercompany payable may be designated as a fair value hedge of the foreign exchange exposure arising from the third-party yen-denominated firm commitment. Parent A has in place a third-party yen-denominated borrowing that offsets the exposure of its yen-denominated intercompany receivable from Subsidiary B during the period the intercompany loan receives hedge accounting.

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.