Director of Research and Technical Activities
File Reference No. 162-B
Financial Accounting Standards Board
401 Merritt #7
Norwalk, Connecticut 06856-5116

Members of the Financial Accounting Standards Board:

This comment letter is submitted by the Treasury Management Association (TMA) in response to the Exposure Draft issued by the Financial Accounting Standards Board (FASB), which would establish accounting and reporting standards for derivative and other similar financial instruments and for hedging activities.

The TMA represents over 9,000 treasury professionals who, on behalf of over 3,500 corporations and other organizations, are significant participants in the nation's payments systems and capital markets.  Many of our members are responsible for their organizations' derivatives activities with the primary objective of risk management.  Organizations represented by our members are drawn generally from the Fortune 1000 and the largest of the middle market companies, and they have an active interest and sizable stake in any accounting standards, regulatory and legislative changes affecting financial reporting of derivatives and other transactions.  We have summarized in an attachment to this letter the steps the Association pursued to assure that this statement is representative of our members' views.

Most of our members report that they do not use derivatives for trading or speculative purposes. Rather, they utilize derivatives to hedge or otherwise manage external financial risks such as interest rates, currency exchange rates, or commodity or equity prices.  Although derivatives are not generally part of the core businesses of end-users, they are important, cost-effective tools for managing various external financial risks which can materially affect the profitability and competitiveness of those core businesses.  These tools have become even more essential as international markets have become more important and as the volatility of interest rates, currency exchange rates and commodity prices has increased.  Other members utilize derivatives to implement or enhance their investment strategies.  Derivatives can be used to take on the risk that the investor wants to assume and to hedge or avoid risks that the investor does not care to incur.  We believe it is critical that the accounting for derivatives appropriately take into account the business context in which derivatives instruments are utilized and that it is the economics of the business which must be fairly and accurately reported, without the distortions of misleading derivatives accounting.

The TMA believes that meaningful, cost justified accounting standards are essential to the efficient functioning of the economy.  We recognize the vital role of FASB in this process.  We appreciate the opportunity to be included in the careful deliberations and testing which must occur prior to the approval of any new standard concerning financial instruments or hedging activities. However, we are concerned that the proposed standard may impair the usefulness of financial reporting, increase financing costs, create expensive reporting requirements, and discourage financial risk management techniques.

In particular, we are concerned that

1. The perceived benefits associated with the proposed standard will not exceed the costs of compliance, and there has been no analysis of economic impacts flowing from the proposal.
    
2. Accounting standards for derivatives should focus on trading activities and  should not be overly burdensome for risk management techniques.
    
3. The proposal may discourage the use of many effective risk management techniques which have evolved over many years.
    
4. The proposal is complex and difficult to understand.
    
5. There has been insufficient field testing of the proposed standard.
    
6. Insufficient time has elapsed for proper analysis of the impact on corporate disclosures of FAS 119 and other evolving practices.
    
7. The proposed standard is a risky interim solution which should be deferred until it can be considered within the context of fair value treatment of all financial instruments.
    
8. Market forces, regulatory requirements and accounting standards already in place have moved business enterprises toward more consistent practices of accounting and reporting of derivatives activities.
    
9. The proposal is biased towards managing risk at the transaction level rather than the more common and economical practice of managing risk at the portfolio level.
    
10. The requirements to qualify for hedge accounting treatment are restrictive and do not permit hedge accounting treatment of many risk management strategies.
     
11. Efforts by the SEC and FASB to improve accounting, disclosure and financial reporting are welcome, but need to be closely coordinated.

These issues are addressed in more detail below.

1. The perceived benefits associated with the proposed standard will not exceed the costs of compliance, and there has been no analysis of economic impacts flowing from the proposal.

These costs include those of preparing financial statements, restructuring current business activities, capturing required information and retraining financial staffs.  For most industrial companies, fair value accounting has an unfavorable cost benefit ratio.  It would require building information systems not generally in use and would generate information that is, by its nature, difficult to use and confusing to shareholders.

Costs of concern to our members include:

• Increased professional costs for auditing, tracking and independent valuations by CPA firms and other third parties
   
• Systems development and operating costs
   
• Increased documentation
   
• Cost and complexity of creating additional book-tax accounting differences
   
• Possible shift from efficient over-the-counter derivatives to exchange traded derivatives which may not be as cost-effective
   
• Increased personnel costs for training, evaluation of changes in hedging strategy, and ongoing administration of hedging activity

If the proposal is adopted as currently constructed, there could be significant economic
consequences for entities using derivatives for risk management because some techniques may not qualify for hedge accounting treatment.  These entities may be exposed to new risks as a result, or may seek alternative risk management tools.

Economic policy and direction is something that should not be unduly influenced by accounting rules and regulations.  There is little or no evidence of economic impact analysis associated with the proposal.

2. Accounting standards for derivatives should focus on trading activities and should not be overly burdensome for risk management techniques.

It is important that accounting standards efforts be focused on trading activities.  Since perfect hedges and underhedges have no overall earnings impact, a material benefit is not provided by having this information reported directly in the body of financial statements.  The more appropriate, cost-justified approach is to have simple, complete, and consistent disclosure requirements for risk management activities.

3. The proposal may discourage the use of many effective risk management techniques which have evolved over many years.

Derivatives now play a vital role in global capital markets.  Implementation of the exposure draft could have a devastating impact on financial markets and favor one financial instrument over another by virtue of the accounting treatment of the different instruments.  Failure to allow for bifurcation of risks in hedged instruments could result in accounting results which are significantly different from the economics of management intent and actions.

This proposal could cause many corporations to curtail their use of derivatives even if it increases their risk exposure or limits their ability to achieve stated financial goals.  These disclosure requirements would do nothing to make this increased risk or reduced efficiency transparent to financial statement users.

4. The proposal is complex and difficult to understand.

The distinction between a fair value hedge and a cash flow hedge is difficult to make.  Accounting results depend on this distinction, leading to complexity and difficulty in implementing the proposal.

Seasoned accounting professionals with extensive experience in financial instrument accounting profess confusion over many of the subtleties and seemingly unintended consequences of the exposure draft.  The proposal places undue emphasis on detail as opposed to presenting the big picture context of how the corporation is using derivatives and managing risk.  We think many financial statement users could be overwhelmed by detail to the point where they cannot see the proverbial forest for the trees even if this perspective is provided.

5. There has been insufficient field testing of the proposed standard.

The proposal requires change of such a large magnitude that the entire process needs to be thoroughly tested.  FASB staff has recognized the need for additional field testing.

The proposed standard would result in accounting recognition which does not reflect management's intent upon entering into derivatives transactions.  For example, the proposal would eliminate the current accounting practice which treats gains/losses on hedges of forecasted transactions as a basis adjustment; rather the proposed framework would require that the full gain/loss on the hedging transaction be recognized in earnings on the forecasted transaction date thereby resulting in accounting recognition which ignores management's intent.

6. Insufficient time has elapsed for proper analysis of the impact on corporate disclosures of FAS 119 and other evolving practices.

Insufficient time has elapsed for proper analysis of the impact of FAS 119 on corporate disclosure practices.  In fact, the first publicly available analysis by FASB staff of selected 1994 reports is contained in Special Report No. 156-A released in December 1995.

TMA's own recently completed survey work reveals increased disclosures in most areas when compared with the FASB analysis. A copy of the 1996 TMA Derivatives Survey is attached to this letter.

• 83 percent of this TMA sample include disclosures about derivative financial instruments in the notes to the financial statements, in management's discussion, or both, versus 78 percent of FASB's sample.
   
• 83 percent of those who do disclose derivatives-related activities disclose notional amounts, versus 96 percent of the FASB sample.
   
• 86 percent of the TMA sample firms provide information by class of financial instruments versus 78 percent of the FASB sample.

While only 16 percent of the FASB sample of firms made any disclosure, about either use or non-use for trading purposes, 74 percent of the TMA sample firms' financial statements stated whether or not derivative financial instruments were held or issued for trading purposes.

We believe that this positive trend will continue with the reports for the current reporting period, and with the reports filed for the 1996-1997 period.

Several factors explain the increase in voluntary quantitative risk disclosures by dealers and end users during the last few years.  First, market participants have begun demanding more such disclosures, and companies have responded to those demands.  Second, the "science" (or "art") of risk measurement has evolved considerably over the last several years.  The rapid pace of innovation continues.  Finally, software systems have evolved to the point that companies -- especially end users of derivatives -- can now more readily utilize these systems to measure their market risk.  Such systems are increasingly purchased from outside vendors, whereas they previously were designed in-house almost exclusively for internal use.  This restricted their use to major derivatives dealers.

No reasons can be identified to suggest that these powerful trends in innovation for market risk measurement and disclosure will slow.  Market forces should be given an opportunity to ensure adequate disclosure of material information.

7. The proposed standard is a risky interim solution which should be deferred until it can be considered within the context of fair value treatment of all financial instruments.

The proposal does not provide for consistent accounting treatment for cash instruments and economically equivalent synthetic instruments utilizing derivatives.  This disparity will likely trigger significant unintended consequences.

8. Market forces, regulatory requirements and accounting standards already in place have moved business enterprises toward more consistent practices of accounting and reporting of derivatives activities.

The private sector is moving toward responsible and well-managed use of derivatives.  The latter half of 1995 saw the publication of documents reflecting major efforts toward self-regulation, by both end-user and dealer organizations.  In fact, TMA's Voluntary Principles and Practices Guidelines for End-Users of Derivatives has been requested by over 1,000 of our members. This document is an Attachment to this letter. This document is designed to help treasury practitioners develop an appropriate framework of internal controls and disclosures specific to their organizations.

Two groups of dealers released "principles and practices" publications directed at dealer/end-user relationships and have generated debate on the responsible management of those relationships.

The public sector, through the actions of federal regulatory agencies and banking supervisors, has recently undertaken numerous actions to protect the integrity and effective functioning of U.S. financial markets and to address public concerns about derivatives.  Starting in 1993, The President's Working Group on Financial Markets undertook a vigorous review of recent developments in financial markets, particularly with regard to derivatives.  In late 1994, The Working Group reported on its review, documenting the breadth and depth of the regulatory agencies' efforts in addressing concerns about derivatives.  The report summarized over 80 actions undertaken by regulators to reduce risk in financial markets.

These developments together with ongoing debate and market forces promote improved disclosure of material information, and facilitate steadily improving accounting and reporting practices.

9. The proposal is biased towards managing risk at the transaction level rather than the more common and economical practice of managing risk at the portfolio level.

The proposal precludes specialized accounting treatment for many widely utilized hedging strategies managed at the balance sheet or business unit level.  Specifically, the restriction against partial hedges of fair value exposures would deter entities from hedging economic risks on a macro basis since such activities would likely result in earnings volatility and increased administrative costs.

In efforts to improve efficiencies of sound risk management programs, end users have increased portfolio hedging and reduced transaction hedging.  The exposure draft discourages portfolio hedging.  In some cases the proposed parameters for hedge accounting of transaction hedges are extremely tight, e.g. lack of flexibility to roll over hedges for unexpected changes in timing of the underlying transactions.

10. The requirements to qualify for hedge accounting treatment are restrictive and do not permit hedge accounting treatment of many risk management strategies.

The proposal outlines a number of arbitrary exclusions which would disqualify certain hedging strategies from obtaining hedge accounting treatment.  This may force companies to use risk management techniques that are less efficient or more costly, solely to achieve an accounting result that reflects their risk management objectives.  For example, rollover hedging strategies, which are commonly used when longer-term derivatives are not available, or if liquidity conditions cause longer-term alternatives to be unattractively priced, have been arbitrarily excluded as risk management practices unable to obtain hedge accounting treatment.

The framework of the proposal would provide very different accounting for hedges of firm
commitments and hedges of forecasted transactions, when in reality the economic objectives are substantially the same.

The proposal provides separate accounting recognition requirements for cash flow and fair value hedges.  We do not believe such risk management activities should be accounted for differently.

11. Efforts by the SEC and FASB to improve accounting, disclosure and financial reporting are welcome, but the efforts need to be closely coordinated.

The TMA agrees with senior SEC officials who believe that we must avoid the temptation to demonize derivatives, which have become a vital tool in global financial markets.  It is important for all parties to recognize that significant improvements have been made in the control and use of derivatives.  For the most part, sound internal controls have been established, dealer sales practices are more closely monitored, end users are more knowledgeable, better disclosures are being made, procedures to prevent excessive leverage have been installed, dealer capital standards are better defined, and there is more regulatory scrutiny of derivative markets.  These positive developments are effectively addressing fears and concerns of the general public.  The TMA believes improvement should continue on an evolutionary path.

Recognizing that global derivatives constitute a multi-trillion dollar marketplace, FASB needs to move cautiously and deliberately to avoid triggering significant dislocation.

*  *  *  *  *

Conclusion and Recommendations

The majority of respondents to TMA's recently completed membership survey reported that the FASB exposure draft would not result in significant additional information value for users of financial statements to offset the cost of compliance.  Key conclusions drawn from the survey indicate that:

• The majority of respondents find the additional reporting requirements proposed by FASB for both fair value hedges and cash flow hedges to be a moderate or great expense.
   
• Respondents do not believe the reporting proposed for fair value hedges and cash flow hedges will improve financial statement users' understanding of firm operations.  Half of the respondents believe there will be no improved understanding while a scant one percent believe there will be a very great extent of improved understanding by statement users.
   
• 38 percent of respondents report that, as a consequence of FASB's proposal, the increase in volatility of balance sheet numbers would be significant.
   
• One fourth of the respondents can determine fair values only to a small extent or not at all, due to the unique nature of some negotiated over-the-counter derivative financial instruments.

We applaud FASB's objective to develop accounting standards to advance financial reporting, but we question whether fair value statements would present justifiable improvements on current reporting practices.  We also call into question the utility of such reporting to users' understanding of a firm's operations and worth.

We believe that FASB should consider alternatives to implementing this exposure draft.  Pursuit of more modest goals should be explored.  TMA recommends that FASB examine the following alternatives to the current proposal:

Alternative 1 - Develop a standard that codifies current practice together with appropriate disclosures, and eliminate inconsistencies and complexities systemic to current practice.

Alternative 2 - Revise hedge accounting criteria to permit all risk management activities to qualify for hedge accounting treatment.

Alternative 3 - Suspend implementation of this costly interim solution until an approach can be coordinated with the Board's stated goal of measuring all financial instruments at fair value.

We feel strongly that any actions taken in this area should be pursued in concert with the Securities and Exchange Commission's efforts to improve qualitative and quantitative disclosures for financial instruments.

We appreciate the opportunity to offer these comments.

Sincerely,

/s/ Thomas D. Logan, CCM
Treasurer
Basic American, Inc., and
Chair, Government Relations Committee
Treasury Management Association

/s/ Patrick M. Montgomery, CCM
Assistant Vice President, Finance
ULLICO, and
Government Relations Committee
Treasury Management Association

/s/ Frank P. Curran
Vice President
Government Relations and Technical Services
Treasury Management Association

Attachments:

• Process Used to Develop FASB Comments
• 1996 Derivatives Survey
• Voluntary Principles and Practices Guidelines for End-Users of Derivatives

Attachment

1. Distributed in June 1996 to 3,100 members a survey instrument which had a two-fold purpose:

1. to determine respondents' views on and organizations' capabilities to comply with reporting requirements identified in a SEC proposal on derivatives and market risk management
    
2. to determine respondents' views on and organizations' capabilities to comply with FASB's proposed changes in hedge accounting

A total of 319 responses, or ten percent of the 3,100 surveys distributed, were received.  The respondents collectively represent a broad cross-section of TMA members.  59.6 percent of the respondents are employed at publicly held corporations while 38.9 percent are with privately held corporations.  The majority of respondents (81.2 percent) are with a parent organization while the remainder are employed at the divisional or subsidiary level.

Respondents represent businesses of all sizes, from under $25 million in total revenues to over $209 billion.  The majority (58.8 percent) of respondents' organizations have over $500 million in revenues.

Respondents represent a wide diversity of industries.  The manufacturing sector represents the single largest category of respondents, accounting for 31.7 percent of all respondents.  After manufacturing, the next largest industry representations are those of financial services (7.8 percent of respondents), insurance (7.5 percent), health services (6.9 percent), and retail (6.0 percent).

The results of the survey are enclosed in an attachment to these comments.

2. Held discussions with a number of other organizations with interest in the Exposure Draft. These organizations include American Bankers Association (ABA), Financial Executives Institute (FEI), National Association of Manufacturers (NAM), American Institute of Certified Public Accountants (AICPA), National Association of Corporate Treasurers (NACT), International Swaps and Derivatives Associations (ISDA) and End Users of Derivatives Association (EUDA).

3. Conducted teleconference call meetings with TMA's Government Relations Committee, which was charged with the responsibility of developing the Associations comment.

4. Solicited comments from approximately 65 regional treasury organizations.

5. Sought comments through direct personalized mailings from almost 500 chief financial officers, controllers and vice-presidents of finance who are members of the TMA.

6. Met in New York on September 20 with a FASB staff official and representatives of other interested organizations to exchange views on the Exposure Draft.

7. Generated these comments cooperatively through the efforts of members of TMA's Government Relations Committee.