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Derivatives Implementation Group

Statement 133 Implementation Issue No. H14

QUESTION

In instances in which a qualifying foreign currency cash flow hedging relationship exists based on paragraph 40A(b)(2) of Statement 133 and the exposures arising from multiple internal derivative contracts are aggregated or netted for each foreign currency, could the treasury center enter into a third-party position with neither leg of the third-party position being the Treasury Center's functional currency to offset its exposure.

BACKGROUND

Paragraph 40B of Statement 133 permits a Treasury Center to offset exposure arising from multiple internal derivative contracts on an aggregate or net basis if the following conditions are met:

1. The issuing affiliate enters into a derivative contract with an unrelated third party to offset, on a net basis for each foreign currency, the foreign exchange risk arising from multiple internal derivative contracts, and the derivative contract with the unrelated third party generates equal or closely approximating gains and losses when compared with the aggregate or net losses and gains generated by the derivative contracts issued to affiliates.

2. Internal derivatives that are not designated as hedging instruments are excluded from the determination of the foreign currency exposure on a net basis that is offset by the third-party derivative. In addition, nonderivative contracts may not be used as hedging instruments to offset exposures arising from internal derivative contracts.

3. Foreign currency exposure that is offset by a single net third-party contract arises from internal derivative contracts that mature within the same 31-day period and that involve the same currency exposure as the net third-party derivative. The offsetting net third-party derivative related to that group of contracts must offset the aggregate or net exposure to that currency, must mature within the same 31-day period, and must be entered into within 3 business days after the designation of the internal derivatives as hedging instruments.

4. The issuing affiliate tracks the exposure that it acquires from each hedging affiliate and maintains documentation supporting linkage of each internal derivative contract and the offsetting aggregate or net derivative contract with an unrelated third party.

5. The issuing affiliate does not alter or terminate the offsetting derivative with an unrelated third party unless the hedging affiliate initiates that action. If the issuing affiliate does alter or terminate the offsetting third-party derivative (which should be rare), the hedging affiliate must prospectively cease hedge accounting for the internal derivatives that are offset by that third-party derivative.
   

RESPONSE

Yes. In a qualifying foreign currency cash flow hedge that exists based on paragraph 40A(b)(2) and in which the exposures arising from multiple internal derivative contracts are aggregated or netted for each foreign currency, the Treasury Center could enter into a third-party position with neither leg of the third-party position being the Treasury Center's functional currency to offset its exposure provided that the amount of the respective currencies of each leg are equivalent with respect to each other based on forward exchange rates. Paragraph 40B requires that the derivative contract(s) with the unrelated third party provides offset for each foreign currency exposure and that the gains and losses generated from the third-party derivative contract(s) generates equal or approximating gains or losses generated by the internal derivatives entered into between the subsidiaries and the Treasury Center. For example, if a US Dollar functional currency Treasury Center was short 390 Euros and long 40,684.80 Yen after netting its exposures obtained from internal derivative contracts and the forward exchange rate between Euros and Yen was 1.00 Euro = 104.32 Yen, then the Treasury Center could enter into a third-party receive 390 Euros/pay 40,684.80 Yen contract to offset the exposures. In contrast, if the Treasury Center was short 390 Euros and long 51,000 Yen, then the Treasury Center would need to enter into 2 third-party contracts with the receive leg of the second third-party position being the Treasury Center's functional currency. For example, the Treasury Center could enter into a third-party receive 390 Euros/pay 40,684.80 Yen contract to offset the Euro exposure and partially offset the Yen exposure. It would then need to enter into a receive functional currency/pay Yen contract to hedge the remainder of its Yen exposure.

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.