FASB Foreign Currency Hedges Hedging Foreign-Currency Denominated Interest Payments

FASB: Foreign Currency Hedges: Hedging Foreign-Currency Denominated Interest Payments

Derivatives Implementation Group

Statement 133 Implementation Issue No. H4

Title: Foreign Currency Hedges: Hedging Foreign-Currency Denominated Interest Payments
Paragraph references: 21, 29, 37, 40, 540
Date cleared by Board: July 28, 1999
Affected by: FASB Statement No. 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities
(Revised September 25, 2000)

QUESTION

May a company treat foreign-currency-denominated fixed-rate interest coupon payments arising from an issuance of foreign-currency-denominated fixed rate debt as (a) an unrecognized firm commitment that may be designated as a hedged item in a foreign currency fair value hedge or (b) forecasted transactions that may be designated as hedged transactions in a foreign currency cash flow hedge?

BACKGROUND

A company whose functional currency is the U.S. dollar issues fixed-rate debt denominated in a foreign currency. The debt has a fixed interest coupon that is payable semi-annually in that foreign currency. The company wishes to lock in, in U.S. dollar functional currency terms, the future interest expense that will result from the debt and enters into a derivative instrument to hedge the foreign currency risk of the fixed foreign-currency-denominated interest coupon payments. For example, the company may enter into a foreign currency swap to receive an amount of the foreign currency required to satisfy the coupon obligation in exchange for U.S. dollars at each coupon date, or, alternatively, it may enter into a strip of foreign currency forward contracts that provide for receipt of an amount of foreign currency required to satisfy the interest coupon obligation in exchange for the payment of U.S. dollars at each coupon date.

Paragraph 37 of Statement 133 states:

     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. The designated hedging relationship qualifies for the accounting specified in paragraphs 22-27 if all the fair value hedge criteria in paragraphs 20 and 21 and the conditions in paragraphs 40(a) and 40(b) are met. [Footnote reference omitted.]

Paragraph 40 of Statement 133 states, in part:

     A derivative instrument designated as hedging the foreign currency exposure to variability in the functional-currency-equivalent cash flows associated with a forecasted transaction…, a recognized asset or liability, an unrecognized firm commitment, or a forecasted intercompany transaction…qualifies for hedge accounting if all of the following criteria are met:
  1. For consolidated financial statements, either (1) the operating unit that has the foreign currency exposure is a party to the hedging instrument or (2) another member of the consolidated group that has the same functional currency as that operating unit (subject to the restrictions in this subparagraph and related footnote) is a party to the hedging instrument. To qualify for applying the guidance in (2) above, there may be no intervening subsidiary with a different functional currency. (Refer to paragraphs 36, 40A, and 40B for conditions for which an intercompany foreign currency derivative can be the hedging instrument in a cash flow hedge of foreign exchange risk.) [Footnote reference omitted.]

  2. The hedged transaction is denominated in a currency other than the hedging unit's functional currency.

  3. All of the criteria in paragraphs 28 and 29 are met, except for the criterion in paragraph 29(c) that requires that the forecasted transaction be with a party external to the reporting entity.

  4. If the hedged transaction is a group of individual forecasted foreign-currency-denominated transactions, a forecasted inflow of a foreign currency and a forecasted outflow of a foreign currency cannot both be included in the same group.

Paragraph 540 of Statement 133 includes the following definitions:

Firm commitment

An agreement with an unrelated party, binding on both parties and usually legally enforceable, with the following characteristics:

  1. The agreement specifies all significant terms, including the quantity to be exchanged, the fixed price, and the timing of the transaction. The fixed price may be expressed as a specified amount of an entity's functional currency or of a foreign currency. It may also be expressed as a specified interest rate or specified effective yield.

  2. The agreement includes a disincentive for nonperformance that is sufficiently large to make performance probable.

Forecasted transaction

A transaction that is expected to occur for which there is no firm commitment. Because no transaction or event has yet occurred and the transaction or event when it occurs will be at the prevailing market price, a forecasted transaction does not give an entity any present rights to future benefits or a present obligation for future sacrifices.

RESPONSE

A company may not treat foreign-currency-denominated fixed-rate interest coupon payments arising from an issuance of foreign-currency-denominated fixed-rate debt as an unrecognized firm commitment that may be designated as a hedged item in a foreign currency fair value hedge. The foreign-currency exposure of the future interest payments would not meet Statement 133's definition of an unrecognized firm commitment because the obligation is recognized on the balance sheet-that is, the carrying amount of the foreign-currency-denominated fixed-rate debt incorporates the entity's obligation to make those future interest payments as well as the repayment of principal. However, those fixed-rate interest payments could be designated as the hedged transaction in a cash flow hedge.

The above guidance also applies to dual-currency bonds that provide for repayment of principal in the functional currency and periodic fixed-rate interest payments denominated in a foreign currency. FASB Statement No. 52, Foreign Currency Translation, applies to dual-currency bonds and requires the present value of the interest payments denominated in a foreign currency to be remeasured and the transaction gain or loss recognized in earnings. Thus, those fixed-rate interest payments on a dual-currency bond could be designated as the hedged transaction in a cash flow hedge of foreign exchange risk.

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.