Commentary: Hey, Fasb, What's The Rush?Peter Coy
In Norwalk, Conn., the Financial Accounting Standards Board has kicked up another fuss. It's on the verge of setting new rules that will dramatically alter the way companies account for their use of derivatives--that is, financial instruments used for speculation or risk hedging. While FASB pronouncements are supposed to be "generally accepted accounting principles," these new rules are about as "generally accepted" as rain at a football game. In the interest of harmony, FASB should postpone them for at least a year, so affected companies have more time to suggest improvements and prepare for compliance.
Opposition to the derivatives rules runs deep. Federal Reserve Chairman Alan Greenspan wrote to FASB Chairman Edmund L. Jenkins explaining his objections. Chase Manhattan, Citicorp, BankAmerica, Goldman Sachs, and J.P. Morgan, among others, have weighed in as well. Even Hershey Foods Corp., which hedges its purchases of sugar and cocoa, is sour on the rules.
FOOTNOTES? Actually, the rules are reasonable enough. The FASB wants more disclosure on companies' use of derivatives. The instruments would be reported on balance sheets at their estimated market value, with changes showing up in net earnings. A loss on a derivative could be zeroed out if it were exactly offset by a gain on the instrument that it was supposed to hedge, and vice versa.
That's all to the good. Today, derivatives are mainly relegated to footnotes. And as FASB supporters point out, companies have resisted disclosure initiatives since at least 1895, when the New York Stock Exchange first recommended that listed companies issue annual reports to shareholders.
Nonetheless, FASB is a voluntary, industry standard-setting group, not a government agency, and thus it has a special responsibility to seek consensus--or at least to narrow the terms of debate. So far it hasn't managed to achieve that.
Banks and brokerage firms worry that because of complex rules on timing of recognition of gains and losses, the rules will artificially increase the volatility of the earnings and shareholders' equity in the statements of companies that are big users of derivatives. Stockholders dislike volatility. So, the argument goes, some companies will forgo legitimate hedging with derivatives because it's not worth explaining the volatility to shareholders.
In itself, that objection is unpersuasive. Shareholders have demonstrated they can quickly learn to deal with new ways of presenting data. What's more, some of the volatility that will appear is real, and shareholders have a right to know it's there--if only to conclude it's nothing to be alarmed about.
But timing is a bigger problem. FASB plans to put the rule into effect this December for fiscal years beginning on or after Dec. 15, 1998. That would give institutions just 12 months to study the fine print, rewrite their software, redo their recording and reporting systems, and train people to carry out new rules so complicated that the draft standard runs to more than 130 pages. Banks' and securities firms' backroom operations are already stretched thin preparing for the scheduled European common currency in 1999, and the turn of the millennium (which will make old computer programs read Jan. 1, 1900). "I'm sitting here trying to figure out how I'm going to do all this," says Chase Manhattan Controller Joseph L. Sclafani.
Jenkins believes that he has left the institutions enough compliance time. He points out that the derivatives rule has been gestating for a decade, was delayed once already, and has been modified to take into account an earlier round of objections. Says Jenkins: "We don't find that we're getting overwhelming objections to our standard."
FASB and the Securities & Exchange Commission already have taken several worthwhile steps to improve disclosure on derivatives. That, plus increased awareness of the risks that are involved, have pretty much stopped the abuses that were common in the early 1990s. So what's the rush? Jenkins should take the advice of Greenspan and the banks and put the derivatives rule on ice for now.