FASB Clarifies and Expands Fair Value Hedge Accounting

Given the general complexities of hedge accounting, stakeholders need guidance and clarification as much as possible. As a result, on March 28, 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging—Portfolio Layer Method, which clarifies guidance on ASC 815 and amends ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.

The previous update, ASU 2017-12, established the last-of-layer method in an attempt to make more accessible the fair value hedge accounting of interest rate risk for portfolios of prepayable financial assets. The last-of-layer method allows an entity to hedge exposure to fair value changes due to changes in interest rates for a stated portion of the portfolio that is not likely to be affected by prepayments, defaults, and other events affecting the timing and amount of cash flows. This method applies to closed portfolios of fixed-rate prepayable financial assets or one or more beneficial interests secured by a portfolio of prepayable financial instruments, such as mortgages or mortgage-backed securities.

The new update, ASU 2022-01, renames this procedure the “portfolio layer method” and responds to stakeholder feedback about its application. With these changes, the FASB hopes to simplify the hedge accounting model and make it so that an entity’s financial reporting would better align with the results of its risk management strategy.

The key provisions of ASU 2022-01 by the FASB include:

  • Expands from a single-hedged-layer method to a multiple-hedged-layer method
  • Expands the scope of the portfolio layer method to include nonprepayable assets
  • Adds flexibility to the types of eligible hedging instruments
  • Provides additional guidance on the accounting for and disclosure of hedge basis adjustments under the portfolio layer method
  • Specifies how hedge basis adjustments should be considered when determining credit losses for the assets included in the closed portfolio.

The ASU applies to all entities that elect to use the portfolio layer method of hedge accounting. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2022, and the interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, and the interim periods within those fiscal years. Early adoption is permitted.

Published on July 05, 2022