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ISDA PRESS REPORT - THURSDAY, NOVEMBER 30, 2000
* Firms Alter Derivatives Use As Rule Change Looms - The Wall Street Journal Europe * OTC Derivatives Market Grows - Financial Times * D.C. Bar Panelists Call for Tax Law Review In Wake of FASB Rule Change on Derivatives - BNA, Inc. * Ops Execs See Raised Profile - Operations Management * UK Association Sets Up Think Tank - Operations Management Firms Alter Derivatives Use As Rule Change Looms The Wall Street Journal Europe - November 30, 2000 By Joe Niedzielski Some big U.S. corporations are altering their use of derivatives in the run-up to a new accounting rule that goes on the books next year, according to a survey of senior financial executives released by Solution133.com LLC. The basic findings of the survey of more than 100 senior executives at Fortune 1000 companies confirm what some observers of the derivatives markets have been saying for several months: Corporations will stick with simple, or plain vanilla, derivatives instruments because of the complexity and requirements of the new rule known as Financial Accounting Standard 133. In its broadest form, FAS 133, requires corporations to report on their balance sheets the fair market value of their holdings of derivatives and that they be marked to market. Corporations have publicly voiced their concerns in recent years that the standard may result in significant earnings volatility and hurt their share prices. That concern remains among the top issues for those corporate executives surveyed by Solution133.com, an Internet-based resource of information and tools that lets companies tackle the valuation, accounting and reporting requirements of the new rule. Solution133.com is a joint venture of PricewaterhouseCoopers and Gifford Fong Associates. "Hopefully, all companies that produce U.S.-based GAAP (Generally Accepted Accounting Principles) financial statements are evaluating their use of derivatives and hedges, especially understanding the impact on earnings volatility that could occur as a result of FAS 133," said Stan Friedman, Solution133.com's chairman and chief executive officer. The new standard has also been viewed by many observers as a spotlight into the risk-management profiles of U.S. corporations. That's because the standard also requires corporations to describe their risk-management strategies and reasons for undertaking a particular hedge at its inception. The correlation, or effectiveness, of the derivative with the hedged item must also be tested. Solution133.com said the results of the survey reflect an increasing concern that these requirements expose a company to an unprecedented degree of outside scrutiny. Not surprisingly, those corporations surveyed ranked testing for hedge effectiveness, documenting risk-management strategies and valuing derivatives as their three chief concerns with the new accounting standard, though earnings volatility closely followed. "Some of the large companies that we're dealing with are much more concerned about doing the hedge effectiveness test than anything else," Mr. Friedman said. The survey also suggested that corporations will become more risk adverse and alter their selection of derivatives. "No longer able to defer gains or losses, companies are being forced to review their derivative strategies and internal assessment of risk in more detail," the Solution133.com report said. "Accounting requirements are top of mind as executives evaluate their positions and many companies are anticipating changes or adjustments in their earnings." That has led to an increased focus on avoiding any speculative activity. "The more exotic the instrument, the more likely the internal scrutiny on its merits," the report said. Of the 75% of the corporations surveyed that used derivative, many said they would avoid more customized or targeted derivatives and stay with the plain vanilla type until they fully understood the possibility of any earnings ramifications. OTC Derivatives Market Grows Financial Times - November 30, 2000 The global over-the-counter derivatives market grew by almost 10 per cent in value during the first half of this year, according to Swaps Monitor Publications, a US research group. SMP said the notional size of the global derivatives market grew to Dollars 103,900bn at the end of June 2000, an increase of 9.8 per cent from Dollars 94,600bn in outstanding derivatives transactions at the end of 1999. Interest-rate swaps increased by 11.1 per cent in the first half of the year to a total notional value of Dollars 58,500bn from Dollars 52,000bn at the end of 1999. The swaps, which involve the swapping of a fixed-interest rate payment for a floating rate one on debts of same maturity and value, are increasingly being used by investors as a means of hedging fixed-income investments. Interest-rate options remained unchanged at Dollars 12,300bn, while interest-rate forwards grew to Dollars 8,600bn from Dollars 8,300bn. The figures are compiled from databases of about 120 global OTC derivatives dealers. D.C. Bar Panelists Call for Tax Law Review In Wake of FASB Rule Change on Derivatives BNA, Inc. - November 29, 2000 The Democratic chief tax counsel for the House Ways and Means Committee said Nov. 28 he thought Congress should review the taxation of derivatives in view of changes to the accounting rules for reporting of gains and losses from derivatives. John Buckley spoke at a program on derivatives presented by the D.C. Bar Section on Taxation Committee on Financial Instruments and Products. Other speakers included Mark Price and Steve Rosenthal of KPMG, and Chuck Wheeler of Alston & Bird. Price said Financial Accounting Standard No. 133, adopted in 1998 by the Financial Accounting Standards Board and amended in June (118 DTR G-7, 6/19/00), requires separate accounting for derivatives, using a mark-to-market approach like that used under Internal Revenue Code Section 475. The new rule requires that any change in the value of the derivative be "booked"--included as a gain or loss in determining the company's income for financial accounting purposes--even if the company has not disposed of the derivative. The result, Price said, is to create increased volatility in the company's determination of income and loss for accounting purposes. Wheeler said that companies do not want this increased volatility to apply to their determinations of income for tax purposes. Price said the accounting profession adopted new standards for derivatives because of numerous problems, including: * incomplete reporting, in that some companies reported no information or reported information only in a footnote; * inconsistent reporting, in that companies used different rules for determining cost and value; * difficulty in applying the accounting rules; and * lack of transparency, in that companies took different approaches in their treatment of derivatives, meaning income was not determined under the same rules and information on financial statements could not be compared with reliability. Issues for Congress to Study Buckley said the mark-to-market approach is slowly being adopted in the tax system. He said it was not something he favored across the board but in his view it made sense for the tax system to apply the mark-to-market approach to derivatives. He said the problems identified by Price in accounting for derivatives also applied to the tax system--there is uncertainty and inconsistency. Buckley also said it would simplify recordkeeping to conform the tax system to the accounting approach, and he favored Congress looking at this question. He said that Congress's adoption of the mark-to-market approach for securities in the early 1990s was the right approach, and he thought that the Financial Accounting Standards Board had taken an "interesting and important step" in adopting FAS 133. Buckley said he sees the problem of defining a derivative as a major issue for the tax law, and questioned whether the accounting definition was "workable." Other panelists said it is, but Price noted that the definition is very fact-specific, and Wheeler said the rules are so new it is too early to tell whether companies will attempt to structure transactions to use the accounting definition. Buckley said an additional issue would be whether gains and losses from derivatives should be treated as capital or ordinary under a mark-to-market approach. Hedge Accounting Reduces Volatility Wheeler said that some companies show reserves on their financial statements to account for potential losses in value, but that this is not generally used for tax reporting. Rosenthal said a current Tax Court case involves the Internal Revenue Service disputing a company's use of a "credit adjustment" to reduce income. Price said the rules allow companies to elect to use "hedge accounting." He said a company which recognized gain or loss from a derivative identified as a hedge could have an offsetting gain or loss from the item being hedged. Thus, hedge accounting reduces the volatility created by FAS 133 for companies that hedge their risk. However, FAS 133 contains a strict definition for a hedge, and an item could lose its character as a hedge because the definition is reapplied every quarter to the same item. The panelists noted that for tax purposes, once an item is considered a hedge, its character would not change subsequently. Price said the new FASB rule applies to entities that report to the Securities Exchange Commission and are effective for fiscal years beginning after June 15, 2000, and Jan. 1, 2001, for companies reporting on a calendar year. Ops Execs See Raised Profile Operations Management - November 27, 2000 Operations and technology executives are taking on a larger role within firms and ate receiving more senior job titles as a result, according to a Russell Reynolds Associates study to be released this week. "The head of operations is no longer just a senior v.p., but is now at the partner level," said George Wilbanks, partner with Russell Reynolds. The shift has been prompted by a number of factors, including the blurring of lines between banks, insurers, mutual fund firms and other financial services companies, and the growing importance of multiple channels and the subsequent complexity of operations and information. "Firms need much more robust technology and operations platforms to handle the added complexity," Wilbanks said. The study - 2000 Recruiting Trends in Investment Management" - also found an increase in the number of searches in operations, because many firms do not have someone in place who can take on a more executive role. U.K Association Sets Up Think Tank Operations Management - November 27, 2000 . The Computing Services and Software Association, the U.K. trade association for the IT services and software sector, is establishing a think tank to investigate applied technology in the financial and business sectors. The idea originated with members, who were noticing the proliferation of technology initiatives and wanted ways to navigate them, said Andrew Muir, director of global securities solutions for Mercator, and chair of the banking and finance group for CSSA. With so many software initiatives, it is difficult for the industry to know how to direct research and development to apply the evolving technology, explained Muir. For example, SWIFT's SWIFTNet, the new Internet Protocol based network, will impact on initiatives such as Continuous Linked Settlement and the Global Straight Through Processing Association, Muir said. The bi-monthly meetings will begin Dec. 14 in London and then white papers will be issued to promote thought and provide direction to the industry, Muir noted. Muir will head up the soon-to-be-named think tank and will be joined by Anthony Kirby, the ax-executive director of the GSTPA, who is now heading up a team responsible for B2B at Bolero.net, and John Wilson, a director with London-based consultancy CityIQ. There will also be senior representatives from the leading securities firms, including Deutsche Bank and UBS Warburg, and other vendors, an industry official noted. Calls to Wilson and Kirby were not returned. End of ISDA Press Report for Thursday, November 30, 2000. THE ISDA PRESS REPORT IS PREPARED FOR THE LIMITED USE OF ISDA STAFF, ISDA'S BOARD OF DIRECTORS AND SPECIFIED CONSULTANTS TO ISDA. THIS PRESS REPORT IS NOT FOR DISTRIBUTION (EITHER WITHIN OR WITHOUT AN ORGANIZATION), AND ISDA IS NOT RESPONSIBLE FOR ANY USE TO WHICH THESE MATERIALS MAY BE PUT
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