First came Financial Accounting Statement 133, and there was much grumbling.
Then came FAS 138 - a series of amendments to FAS 133 - and there was some relief, followed by more grumbling.
Now, less than three months before the Jan. 1 deadline for all companies to comply with FAS 133 and its amendments, many companies just now are realizing how much work is involved in disclosing on their quarterly balance sheets the impact of their derivatives strategies and how and why they are using those strategies. And as they do, the grumbling is turning into a howl of discontent among companies who must implement FAS 133.
"This thing has more tentacles than an ocean full of octopus," said Robert Sullivan, co-leader of the Americas Financial Risk Management Practice of PricewaterhouseCoopers LLP, New York. "This rule is like no other with regard to the devil being in the details, and too many companies have not gotten to the details."
Some companies have appealed directly to the Financial Accounting Standards Board, which authored FAS 133 and its amendments, asking for a host of amendments they believe will make the standards more fair and easier to implement.
FAS 133 requires companies to report the fair value of their derivatives exposures and hedges in detail on their balance sheets. It further requires that those exposures and hedges be marked to market, or reflecting the prevailing value at the time of the reporting and requires that hedges perform in a "highly effective" manner as measured by various tests. Gains or losses that don't meet the test standards are treated as income, which could lead to earnings volatility. It's something companies have not done in detail in the past.
"[Companies] don't want to have that volatility showing on their balance sheet," said Mark C. Abbott, vice president for risk management and analytics at BlackRock Inc., New York.
While companies may not like the idea of reporting their derivatives strategies and hedges in greater detail, institutional investors who own stock in those companies don't seem nearly as concerned about the potential for volatility.
"We're pretty comfortable that we're not going to be affected," said Rollie Wisbrock, a spokesman for the $35 billion Oregon Public Employees' Retirement System, Salem.
Ken Menke, deputy in charge of domestic equities for the $107 billion Florida State Board of Administration, Tallahassee, said the fund's external money managers will be monitoring stock volatility.
A pension fund investment officer who did not want to be named said he did not expect his fund to make any changes to its portfolio based on potentially more volatile numbers. He also said he welcomed volatility, adding it is a good tradeoff for greater financial disclosure.
Implementation of FAS 133 is proving to be as complex as the derivatives strategies and hedges themselves. Software vendors, particularly those with risk-management products, are scrambling to get programs to market that will help companies calculate the fair value of their derivatives holdings and produce it in terms that can be translated to the required reports.
Aside from implementation challenges, companies are concerned about the effect FAS 133 might have on their stock prices. Often the true value of a derivative strategy or hedge isn't realized until some future date. Starting in January, however, all companies must report the exposures of such strategies on their quarterly financial reports - a move some executives believe could lead to bottom-line volatility because of the complex nature of derivatives and hedge strategies. That volatility, in turn, could lead to investor unease.
"The volatility is going to come in where companies are speculating on derivatives," said Kevin Stoklosa, a project manager at Norwalk, Conn.-based FASB. "And that's not necessarily bad, because if you have derivatives and you're speculating on them, investors should know about that."
Not everyone agrees. In an Aug. 31 letter to FASB Chairman Edmund Jenkins, Timothy Howard, Fannie Mae executive vice president and chief financial officer, said the FAS 133 provision governing reporting of the use of option-based derivatives could cause "substantial" earnings volatility for Fannie Mae.
"(It) would be difficult for investors or security analysts to interpret" that volatility, Mr. Howard wrote. "I suspect this may be the case for other companies affected by the provision as well. Given the magnitude of the earnings volatility that we believe will be generated under the (FAS 133) hedge accounting model for option time value, we request that the board make every effort to consider an amendment to FAS 133 to remedy this issue."
In his letter, Mr. Howard recommended the premium for a purchased hedge option be amortized into earnings over the life of the derivative, provided the company is able to and plans to hold the option to maturity. The difference between the unamortized premium paid for the option and the market value of the time value component would be recorded separately.
Fannie Mae subsequently contacted 43 other companies across a broad spectrum of industries and asked them to send similar letters to the FASB, Fannie Mae spokeswoman Lesia Bullock said.
"A handful did not return our calls, a handful said they were in favor of implementing (FAS 133), but the others agreed with Fannie Mae's ... concerns with FAS 133," she said. "The companies said they would write or call the FASB to express their concerns and seek individual meetings. The FASB never gave us any timeline or guarantee that they would act on our proposed changes. It's an uphill battle."
Mr. Stoklosa said FASB receives letters like those from Fannie Mae all the time, and reads every one. Not all of those letters will lead to action by the board to further amend FAS 133, he said.
FAS 138, a series of amendments to FAS 133, came out of a special group - the Derivatives Implementation Group - formed by FASB to address implementation questions. DIG was composed of representatives from the five largest U.S. accounting firms, and representatives from manufacturing, banking and insurance industries. DIG recommended changes that clarified some definitions and foreign currency exchange policies and allowed more exceptions to FAS 133.
Mr. Stoklosa said he is not convinced volatility is a bad thing, especially when it results from increased financial disclosure. Investors, he said, should have as much information as possible. And, he added, in cases in which companies are using derivatives purely for hedging, there shouldn't be that much volatility.
"Some people look at volatility as being bad. It is what it is," Mr. Stoklosa said. "I don't see anything wrong with reporting a derivative. Maybe it's a risky derivative, but that's not necessarily bad."
Mr. Stoklosa acknowledged FAS 133 is a complicated standard, and that not everyone agrees its exceptions and inclusions are balanced correctly to provide an accurate financial portrait. He did not rule out the possibility that more amendments might be brought forward, but said none is on the horizon.
Regardless, all companies must comply with FAS 133. With the Jan. 1 deadline looming, several firms are working on ways to make implementing the accounting function easier. Among them are research firm Gifford Fong Associates, Walnut Creek, Calif., and PricewaterhouseCoopers. Mr. Fong has teamed up with PwC to develop a web-based accounting method to comply with FAS 133. Solutions 133, at www.solutions133.com, will include the ability to store and price a range of derivatives products and will provide different hedge effectiveness measures, Mr. Fong said. The results will be produced in a format ready to plug in to FAS 133 reporting forms.
Measurisk.com, New York, has similar FAS 133 implementation tools on its website, said Kelsey Biggers, Measurisk.com chief executive officer and president. Measurisk.com counts General Electric Co. and E.I du Pont de Nemours & Co. among its clients.
Other software companies and even banks are developing strategies to help clients deal with FAS 133 accounting and risk measurement.
Everyone agrees implementing the standard will involve hours of work and lots of money. Estimates for implementing accounting systems for FAS 133 range from $500,000 to upwards of $2 million, depending on the company and the extent of its hedging activities.
But it could be far more costly not to implement accounting practices for FAS 133. The Securities and Exchange Commission has regulatory oversight; companies that otherwise must comply with U.S. generally accepted accounting principles and that do not conform to FAS 133 could face fines.
All of this may make companies less likely to engage in hedging.
"If someone is an active hedger, they're going to have five times as much work to do to meet the FAS 133 requirements," said BlackRock's Mr. Abbott. "It's going to cause a lot of headaches. As a result, you're going to see a lot of companies that will just stop hedging."
Mr. Sullivan of PwC said companies may not stop hedging, but the hedges they engage in will need to become more efficient to avoid unwanted volatility in earnings.
Investors, he said, should ask companies in which they hold stock pointed questions about how they manage financial risk; what impact FAS 133 will have on its risk strategies, accounting and volatility; what kinds of hedges they use now; and whether they plan to stop using hedges. Companies that are involved in major financing activity, that have large foreign exchange risks and that have major activities in commodities stand to be most affected by FAS 133, Mr. Sullivan said.
Not everyone views FAS 133 only in light of its implementation challenges and the volatility it could produce. Mr. Fong said the transparency it brings to financial accounting is needed.
"Transparency is a good thing," Mr. Fong said. "When it comes to the necessary steps to achieve that goal, you're going to run into resistance. People will just have to pay the price for it."