If ever a case can be made for reporting something in more detail, it is for derivatives. The Financial Accounting Standards Board deserves support for its newly proposed rule on derivatives disclosure.
Yet, some powerful corporate and financial-industry executives seek to quash the introduction of the rule, or strip it of its substance, even to the extent of considering help from, of all places, Congress. Some of the reasons they cite for wanting to extenuate the proposed rule - such as the instruments' complexity - are among the very reasons it should be adopted.
With the stock market at record levels this year, derivatives use continues to grow. Investors are using the instruments as an efficient way to seek extra return or to hedge their investments against what could be a costly decline.
The approaching 10th anniversary of the Oct. 19, 1987, stock market crash gives a pointed reminder to the advantages and disadvantages of derivatives. Following the crash, the instruments received untold bad publicity, so much of it undeserving and based on ignorance. Many sophisticated market participants, who didn't use the tools, blamed derivatives for exacerbating the sharp decline. The FASB proposal is an outgrowth of the derivatives troubles in the early and mid-1990s.
Derivatives indeed are complicated instruments. They are difficult to understand. Even some big users fail to understand them, with spectacular consequences. But better understanding of these complex tools will be less likely if they are shoved to the back of financial reports. The purpose and extent of their use and their impact on the financial statements of users should be disclosed.
FASB, based in Norwalk, Conn., recently unveiled a draft proposal for new a rule requiring companies to report their use of derivatives. These instruments includes futures and options and swaps. The underlying securities covered by derivatives include commodities, currencies and financial instruments.
The latter, the most widely used of the derivative instruments in terms of valued traded, include fixed-income and equities, from individual stock futures in Australia to the new Dow Jones industrial average futures and options contracts in Chicago.
Accounting for them will help financial report readers, as well as users themselves, understand them. You can't begin to understand them until you start accounting for them.
The new FASB rule would require corporations to show derivatives at fair market value on their balance sheets. It would mean that the reporting corporations would have to adjust their earnings when warranted by changes in the underlying value of the derivatives they are using.
The FASB proposal runs some 200 pages. That's long and complicated, but so are derivatives. Corporate and financial executives shouldn't back off from disclosure, because derivatives are complex.
These executives seek to simplify the rule, contending it would give corporations more flexibility. But derivatives that are fully disclosed would not prevent flexibility. As readers understand the value of their use, they would support their employment.
If the board adopts the rule, it could go into effect in 1999.
Some opponents suggest putting the matter before Congress. Can you imagine Congress debating derivatives? It would set a precedent for politicizing accounting rule-making, jeopardizing objectivity in financial reporting.