Incomprehensible, unpredictable, unmanageable and downright frightening — FAS 133 is threatening the financial world like an alien life form.

By Robert Hunter

Sometimes the best way to gauge the goings on in the financial world is to follow the traveling sideshow of high-minded discourse known as the conference circuit. This past winter and spring, prominent accounting experts bounced around the world explaining to terrified corporate treasurers the intricacies and nuances of the Financial Accounting Standards Board’s Statement 133, the earth-shattering document that would soon turn derivatives accounting upside down. Implementation Day, June 15, loomed ominously, and few corporates could claim even rudimentary readiness.

When FASB issued a one-year postponement of the standard on May 19, however, after being deluged with pleas from such big-name corporates as Dell Computer, Sun Microsystems and McDonald’s, once-stressed treasurers quickly changed their tune. The next conference, scheduled a week later, was canceled.

“The deeper you look at FAS 133, the uglier it gets.” —Jeffrey Wallace Greenwich Treasury Advisors

Why the turnabout? Most corporate treasurers—not to mention derivatives dealers and auditors—view FAS 133 as an accounting standard completely alien to the way they conduct they’re hedging business. In their heart of hearts, they wish it would simply go away. FASB’s decision to postpone implementation allowed all the affected parties to retreat into their pre-FAS 133 mindset—a swirling confluence of denial, dread, anxiety and utter confusion. Projects as massive and daunting as FAS 133 implementation, it seems, are best put off for as long as possible.

What went wrong?

FASB’s objectives in drafting 133 were ambitious. In the wake of the Procter & Gamble derivatives debacle of 1994, the Securities and Exchange Commission implored FASB to change its treatment of derivatives accounting to bring more transparency to corporate dealings and thereby give investors a more complete picture of a company’s bill of health. FASB responded with nothing short of a total overhaul of current derivatives accounting practices (see “The Nuts and Bolts of FAS 133,” Page 18).

“Our goal,” says Robert Wilkins, senior project manager at FASB, “was to develop a common framework for derivatives accounting, because under the existing literature different derivatives were accounted for in different ways. We thought all derivatives ought to be accounted for comparably. The board decided that derivatives meet the definition of an asset or a liability, and should be recognized on the balance sheet. It’s as simple as that.”

FASB’s grand attempt at simplification and consistency, however, has resulted in a muddled mess for corporates, dealers and auditors alike.

“It’s got to be one of the most cumbersome standards that’s ever been written,” says the treasurer of a major Midwest manufacturing company. “This thing is totally overblown and unrealistic.” Corporates are the hardest hit by 133, because it creates a number of hurdles that could wreak havoc on risk management programs. But since derivatives dealers have always been on the other side of these risk management transactions, a sizable chunk of their business could evaporate as well. Meanwhile, Big-Five accountants are still struggling to comprehend the frustratingly complex standard. “The deeper you look at FAS 133,” says Jeffrey Wallace, managing partner at Greenwich Treasury Advisors, “the uglier it gets.”

Corporate hoops

Many believe FAS 133’s biggest flaw is that it forces corporates to inject volatility into their earnings stream when accounting for derivatives and the ineffective portions of hedges. FASB’s overarching goal of corporate transparency may serve only to confuse even the most sophisticated investors poring over quarterly earnings reports.

Irina Simmons, assistant treasurer at EMC, a Massachusetts-based software company, is incredulous. Her company has marshalled its resources to do what many corporates deemed impossible: It has adopted FAS 133 early, beginning January 1 of this year. But even the earliest known adopter is critical of some of the rules. “The way 133 forces you to do the calculations for hedge ineffectiveness doesn’t seem to be based in reality. You might buy a particular instrument to hedge a particular exposure, and you’re forced under 133 to mark the instrument’s ineffectiveness to market. You might have an instrument that’s ineffective or has a large ineffective impact, but by the end of that instrument’s life, that entire ineffectiveness has gone back to zero. So you get interim volatility, and then at the end of the period—poof, it’s all gone. I’m not so sure that’s the right way for a shareholder to be presented this information. It’s not clear that the accounting is following the risk management objectives of the corporation.

The Nuts and Bolts of FAS 133 The basic requirement of FAS 133 is deceptively simple: Firms must mark to market all derivatives as assets or liabilities at least quarterly, and record them in their income statement. Some derivatives, however, qualify for special hedge accounting treatment, and the rules determining whether or not they do are astonishingly complicated. There are three ways a derivative qualifies for hedge accounting status—if it is a fair-value hedge, a cash-flow hedge or a net investment in a foreign operation. According to FASB, a fair-value hedge is a derivative that hedges the exposure to changes in the fair value of a recognized asset or liability or a firm commitment. The gain or loss is recognized in earnings in the period of change, together with the offsetting loss or gain on the hedged item attributable to the risk being hedged. The effect of that accounting is to reflect in earnings the extent to which the hedge is not effective in achieving offsetting changes in fair value. A cash-flow hedge, says FASB, is a derivative that hedges the exposure to variable cash flows of a forecasted transaction. The effective portion of the derivative’s gain or loss is initially reported as a component of “other comprehensive income” (outside earnings), and is subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. For a derivative designated as hedging the foreign currency exposure of a net investment in a foreign operation, the gain or loss is reported in OCI as part of the cumulative translation adjustment. The accounting for a hedge of the foreign currency exposure of an unrecognized firm commitment or an available-for-sale security is the same as that of a fair-value hedge, while the accounting for a cash-flow hedge applies to a derivative designated as a hedge of the foreign currency exposure of a foreign-currency-denominated forecasted transaction. Once a derivative qualifies for special hedge accounting, it must be determined to be effective. FASB defines effectiveness as a derivative’s ability to generate offsetting changes in the fair value or cash flow of the hedged item. Accountants have interpreted this to mean that a hedge must offset its underlying instrument in a band of 80 percent to 125 percent. A company must assess whether it expects the hedging relationship to be highly effective at inception and throughout the hedge’s term, assess retrospectively whether the hedge has been highly effective throughout the hedge term, and must measure the amount of hedge ineffectiveness and report this in earnings in the period in which they accrue. (There are, however, two exceptions to the last requirement: “underhedges”—that is, when hedges are less than 80 percent effective—in cash flow exposures or net investment in foreign operations are not recorded in earnings.) In addition to a derivative’s performance, FASB devised a fairly restrictive checklist to determine whether a derivative can be considered effective. The hedge and the underlying must have identical notional amounts, must receive or pay rates on related bases, must have identical contract terms, maturity dates or remaining terms, must have identical repricing or reset dates, and must have identical settlement and receive or pay dates. —R.H.

Not surprisingly, the International Swaps and Derivatives Association agrees. “We do not feel that you should separate the accounting for a derivative from the accounting for the underlying,” says Susan Hinko, policy director for the Americas at ISDA, “because you get distortions in your P&L. You’re marking to market the derivative, but it’s really in place to hedge the underlying, and unless you can account for them together, you’re going to have distortions as the derivative changes in value and the underlying is not accounted for. That is our basic position, and has been.”

Others believe the most onerous element of Statement 133 is its treatment of cross-currency interest rate hedges. In explicit language, the standard says that such instruments do not qualify for hedge accounting, meaning that the common practice of issuing debt in foreign currencies to take advantage of attractive foreign bond markets and then swapping the debt back into dollars has been virtually eliminated. Now, to raise money in a foreign currency, multinationals must borrow in that currency—and eat upward of 10 basis points in the process. Meanwhile, smaller domestic firms are essentially limited to dollar-denominated debt. The irony isn’t lost on GTA’s Wallace. “You can do an interest rate swap on dollar debt and convert it from floating to fixed or fixed to floating, and the FASB calls it a hedge. You can do an interest rateswap in Swiss francs, and go from fixed Swiss to floating Swiss, and the FASB calls it a hedge. But if you want to do a Swiss-francs-to-dollars cross-currency interest rate swap, the FASB, in its infinite wisdom, says it does not qualify as a hedge.”

FAS 133 will also affect the very ways in which corporate treasuries operate. Many large multinational corporations have centralized treasury operations that function like in-house banks, where all of the local units’ foreign exchange exposures, including hedges of projected sales, purchases and so on, are consolidated. The central treasury writes internal forward contracts with the units, assuming the local units’ exposures, and then nets these exposures and writes one hedging contract with a derivatives dealer. Under FAS 133, however, central treasuries must offset each intracompany contract with an external, third-party contract.

The results are disastrous, says Deidre Schiela, a partner at PricewaterhouseCoopers and a member of the Derivatives Implementation Group, a committee of advisers convened by FASB to flesh out remaining implementation issues. “By doing this, you will increase operational risk, because any time the volume of transactions increases, the risk of an operational failure increases. You have to send confirmations, transfer cash, do bookkeeping for more contracts and so on. And now that you have more third-party contracts, your counterparty credit risk increases.” Ben Bastianen, treasurer at Johnson Controls, a $16 billion multinational building-controls and automotive company, agrees. “You have a lot more transaction costs, and you need a lot more systems and administrative resources to keep track of all that,” he says. “It just makes the whole business process more cumbersome, complicated and expensive, and you don’t achieve anything more than what you were achieving in the past.”

“The board decided that derivatives meet the definition of an asset or a liability, and should be recognized on the balance sheet. It’s as simple as that.” —Robert Wilkins FASB

Another major problem with 133, say many, is its effectiveness standard. In addition to the obvious valuation and tracking headaches, there are some basic lapses in logic that have yet to be addressed. Take, for example, a company that issues a 10-year fixed-rate note, and decides six weeks later to hedge the exposure with an interest rate swap. Even if the swap passes all of 133’s quantitative effectiveness tests, it would not be eligible for hedge accounting because the reset dates of the swap and the underlying exposure do not match. “133 really drives you to do perfect hedges where you are exactly matching that debt,” says Wallace. “If you don’t exactly match it, it isn’t pretty, because you will most likely have to mark the derivative to market.”

There are other rigidities built in to the effectiveness standard as well. FAS 133 allows for the hedging of forecasted cash-flow items, but the forecast must be correct to within 60 days for the hedge to qualify as effective. In fair-value hedges, meanwhile, companies that use surrogate instruments must make sure the surrogates stay within the 80 percent to 125 percent effectiveness band. The result: “If people see that they’re going to fail the effectiveness test, they’re really going to think twice about using derivatives, because of the added volatility in earnings,” says a Midwest treasurer. “The objective of most corporations is to reduce volatility, not increase it.”

The standard’s treatment of options is another point of contention. Currently, corporates using options to hedge usually amortize the premium over the life of the contract evenly. Under 133, however, the ineffective portion of the option (that is, the premium) must be marked to market. There are two ways to do this. One method divides the premium into “intrinsic value” and “time value,” while the other method divides the premium into “minimum value” and “volatility value.” The time-value or volatility-value components of the two alternative methods are the ineffective components, and those go directly to current income, while the intrinsic value or minimum value are the effective portions, and qualify for special hedge accounting.

The complex rules and increased potential for earnings volatility worry accountants and treasurers alike. “My concern is that 133 will discourage people from buying options as hedges,” says Ira Kawaller, an accounting consultant and a member of the Derivatives Implementation Group. “Particularly in dealing with caps and floors, where we’re talking about time value, there’s a potential for a large amount of income volatility. I’m concerned that the current approach will make people shun options altogether, at the expense of their risk management strategies.”

There are other corporate hurdles as well. The standard’s treatment of embedded derivatives is especially unwieldy. PG&E complained this spring that in order to comply with 133, it must go through 60,000 contracts to identify the embedded derivatives and mark them to market. And for debt issuers, the standard’s rules on interest rate forwards are daunting as well. Naturally, all ineffectiveness must be marked to market, and the FASB has decreed that market interest rate changes include not only the risk-free component but also the general credit-rating sector spread—making for another valuation headache.

“You will increase operational risk, because any time the volume of transactions increases, the risk of an operational failure increases.” —Deidre Schiela PricewaterhouseCoopers

At heart, FAS 133 is unnecessarily complex, say many. “FAS 133 remains almost as mysterious a document today as [it was] two years ago,” says a consultant. Indeed, even auditors are having a difficult time figuring out the standard. GTA, in a study performed earlier this year, found that central auditors rate local auditors significantly worse on their FAS 133 knowledge than on other areas.

To compound problems, complying with the standard is expected to be expensive. The Treasury Management Association has found that 60 percent of corporate treasurers surveyed believed the cost of complying will be “material or substantial.” The GTA study, meanwhile, found that corporates are likely to spend between $61,000 and $209,000 to comply. “FAS 133 is expensive and unclear,” says Johnson Controls’ Bastianen. “We know that it’s going to force us into running our business more expensively than we normally would have.”

Deal breaker

The various corporate headaches created by FAS 133 will be felt doubly by dealers. Simply put, the standard makes it more difficult for corporates to use derivatives to hedge. “Middle-market companies that are not large users of derivatives don’t have mechanisms in place to comply with FAS 133, and they don’t want to go through the hassle of changing their accounting systems to do so,” says ISDA’s Hinko. “They have been effectively ‘disincentivized’ from hedging.”

According to the TMA study, 19 percent of treasurers believe FAS 133 will “affect the extent of their hedging,” and 19 percent said it will determine their choice of hedging instruments. GTA, meanwhile, paints an equally bleak picture, as Figure 1 indicates. Most notable: 33 percent of corporate treasurers said FAS 133 will cause them to decrease their use of cross-currency interest rate swaps to swap dollar debt into foreign currency debt; and 35 percent will decrease their use of cross-currency interest rate swaps to swap foreign currency debt into dollars. Perhaps the most sobering finding in the GTA survey: fully 19 percent say they’ll never do another cross-currency interest rate swap after implementing FAS 133.

The sad result of FAS 133 is that companies that should be putting on hedges to protect their exposures will not. And it’s happening already. “We were on the verge of doing a cross-currency interest rate swap transaction a few months ago,” says Johnson Controls’ Bastianen. “We checked into the accounting for it under FAS 133, met with our auditors, talked with bankers, did a lot of research, and finally came to the conclusion that we simply could not do it because of all the earnings volatility this would create in the P&L.” Companies such as GE Capital Corp. have gone on record as saying they can no longer execute cross-currency interest rate swaps because they “represent 100 percent volatility.”

ISDA’s Hinko notes that corporates have already stopped issuing debt in eurobonds and swapping back to dollars. Several companies, meanwhile, have reportedly done swaps up to December 31, 2000, and others have done long-term swaps in which they can pull the plug and cancel as of December 31, 2000, if the rules don’t change.

A few dealers have put on their thinking caps to develop products that comply with FAS 133. One such product is Merrill Lynch’s Treasury rate lock, which differs from a standard Treasury lock in that it includes a credit spread option to comply with FAS 133. Another method, called a synthetic risk-sharing agreement, allows a corporate to agree to sell an item of equipment to a corporate in another country in the future. In the meanwhile, the two companies can hedge their currency risk by agreeing to adjust the price of the piece of equipment to reflect changes in foreign exchange rates. The resulting structure combines a physical-goods sale with a foreign exchange option, acting much like a double knock-in forward.

Beyond these limited advances, however, derivatives dealers have been largely silent, pretending not to notice the FAS 133 monster sitting in their living room. “My corporate colleagues are saying that the traders are ignoring it, and aren’t coming up with any new ideas,” says a consultant. “Even worse, I have one client who had a dealer recently tell him that cross-currency interest rate swaps were eligible hedges under FAS 133, which is a direct contradiction of reality. This dealer was aware of the issues, and was lying through his teeth.”

Many dealers, he says, are panicking at the prospect of FAS 133, and are willing to do anything to get deals done now. “Now, more than ever,” he says, “it’s caveat emptor for corporates. They should not rely on their investment bank for FAS 133 advice.”

The times are a-changin’

Corporates have to be especially cautious these days because of the stunning number of uncertainties that continue to surround 133. Changes in FASB-issued guidance at this stage can have major impacts not only on future accounting practices but also on existing derivatives portfolios.

The Derivatives Implementation Group was created to assist the FASB staff in pinning down some of the vagaries of FAS 133. It quickly found that it had a gargantuan task. In its bimonthly meetings, the DIG has answered dozens of questions, but many remain. “Although numerous implementation issues have been identified, many more will likely surface as companies attempt to apply the statement,” says Michael Joseph, a partner at Ernst & Young and a DIG member. “Many of the issues have not yet even been presented to the DIG, and many others are pending final resolution.”

Breaking FAS 133 news has become so critical, in fact, that an entire web site, www.fas133.com, is dedicated to the blow-by-blow changes in FAS 133 guidance. And for good reason. Two months after the initial adoption was to take place, there are still questions as to the precise definition of a derivative. “The FASB has an extremely complicated definition of what a derivative is,” says another DIG member. “You would have thought we’d all know what that is by now.”

How FAS 133 Will Change Corporate Derivatives Usage Greenwich Treasury Advisors asked a number of corporate treasurers how FAS 133 will impact their hedging strategies. Here are some of their responses.
Strategy	Increase (%)	Unchanged (%)	Decrease (%)	Undecided (%)
Swapping fixed-rate debt to floating	0	81	10	10
Swapping floating-rate debt to fixed rate	0	78	13	9
Using forward rate agreements	0	77	8	15
Using interest rate caps	0	73	7	20
Using interest rate collars	0	69	15	15
Doing partial-term interest rate hedging	0	53	20	27
Hedging a portfolio of interest rate exposures	0	64	14	21
Hedging commercial paper funding with an interest rate swap going from fixed to floating	0	67	6	28
FX option hedging of forecast external and intercompany foreign currency sales and purchases	7	52	22	19
Using cross-currency interest rate swaps to swap foreign currency debt into dollars	0	53	35	12
Using cross-currency interest rate swaps to swap dollar debt into foreign currency debt	6	39	33	22

One big area of uncertainty is the issue of measuring hedge effectiveness. A number of techniques have been proposed, but a firm answer has remained elusive. “There’s great debate about how this should be done,” says the DIG member. “This is a big deal because companies that have lots of derivatives, like financial institutions, will need to mechanize their accounting processes, and they need to know the mechanics of how to do the effectiveness test before they can spend money on software. Unless we know the answers to some of these pretty fundamental questions about effectiveness, people are slowed down.”

The uncertainty surrounding effectiveness can utterly paralyze hedging efforts. Take, for example, a commercial paper program. In this common corporate funding strategy, the treasurer has to choose from a host of contract terms and maturity dates, and decide, based on the yield curve, whether it’s better to be on the longer end (the 270-day rate) or the shorter end (the 30-day rate). Many treasurers like to put an interest rate swap on top of the commercial paper program, in which the company receives floating and pays fixed, taking the variable rate and turning it into a longer-term fixed rate obligation. “When you do effectiveness testing on something like that,” says PwC’s Schiela, a DIG member, “you don’t really know what the terms of the paper will be in advance, because you make the decision on the spot. So how do you estimate the cash flows? Do you pretend that in the future you’ll have the same proportion of shorter-term commercial paper and longer-term paper? These issues need to be resolved.”

Greenwich Treasury Advisors offers some advice to corporates gearing up for FAS 133 implementation: Develop a greater understanding of potential derivatives embedded in commercial contracts. Develop better procedures for generating and tracking cash-flow forecast exposures. Fully understand the FAS 133 transition implications of fiscal year 2000 first-quarter P&L, “other comprehensive income” adjustments, and the fiscal year 2000 impact on your derivatives book. Develop a post-FAS 133 hedging policy for foreign exchange and interest rate risk management. Develop a pre-FAS 133 hedging strategy to close out the “bad” derivatives and convert transition P&L and “other comprehensive income” gains and losses into net fiscal year 2000 P&L gains. Buy a system in fiscal year 2000 to manage the FAS 133 accounting.

The issue of embedded derivatives remains a bugaboo as well. Various methods for identifying the derivatives within structured products have been proposed, but FASB has not settled the issue—even for products as common as convertible debt instruments and put bonds.

Beyond these macro issues, a number of more specific questions remain. According to the FAS 133 web site, questions about prepayment provisions, hedging net investments with a cash/derivative combination, ineffectiveness in net investment hedges, the use of compound derivatives, the frequency of designation of hedged net investments, prepaid interest rate swaps, volumetric production payments, and many others, remain unanswered.

Meanwhile, FASB is rumored to be working on two amendments to 133: centralized treasury netting and an option for prospective adoption in light of bigger corporates’ huge existing derivatives portfolios. Both could radically change the way corporates prepare for implementation.

Despite the potential for such big changes, however, FASB is surprisingly unsympathetic to corporates complaining about the difficulty in getting information. The one-year postponement, FASB believes, should take care of that. “What was apparent when we made our decision to postpone was that sometimes the people who did the accounting didn’t talk to the people who were doing the risk management,” says FASB’s Wilkins. “So the people doing risk management didn’t realize what the accounting impact of 133 would be and what types of derivatives they’d need to achieve hedge accounting, because the rules were changing. The postponement is an opportunity for them to increase their communications and get everyone up to speed.”

The conference circuit will heat back up in the fall and winter, says Wilkins, and FASB has created an educational CD-ROM called “A Review of Statement 133: Accounting for Derivative Instruments and Hedging Activities” to answer major questions. “They just need to realize that it will take some time to understand and apply the new rules on this complex topic.”

But this may not be enough. Some conspiracy theorists see FAS 133 as a stepping stone to even more onerous accounting standards in the future. “What FASB really wants is to mark everything to market,” says a dealer. “So they came up with a derivatives standard that tries to give a little here and a little there and ends up creating a total mess of confusion. Perhaps in the back of FASB’s mind is the hope that people will be so miserable with this standard that they’ll finally welcome mark-to-market accounting for everything. That would make things quite Machiavellian and nefarious, of course, but I can only assume that a byproduct of all of this angst and displeasure could be a nice secondary result for FASB.”

The systems nightmare One of the main reasons FASB decided to postpone implementation of FAS 133 was the sorry state of systems readiness in corporate America. The scores of treasurers who wrote to FASB begging for the delay complained that with Y2K and the euro bearing down on them, they simply didn’t have the time—or the resources—to get their treasury systems up to speed for FAS 133. They weren’t lying. According to Edward Berko, head of the risk management systems practice in the financial risk management group at PricewaterhouseCoopers, there are two levels of systems issues that make FAS 133 compliance difficult. At the macro level, most financial institutions and corporations have unconsolidated treasury systems. They may account for their bonds, for instance, in a system that handles only bonds, but they may account for their fixed-income swaps, caps, floors and swaptions in another system entirely. Since FAS 133 requires that the hedging derivative transactions and the underlying hedged transactions be monitored in tandem, this is an obvious problem. Moreover, FAS 133 requires an industry standard mark-to-market capability to comply with FAS 133’s minimum quarterly reporting. “Many corporates can’t price their derivatives portfolios more frequently than annually,” says Berko. “Typically, they don’t have a system that can do the mark to market—so they call a broker or the counterparty or market-maker who sold them the transaction for a mark-to-market value. But with 133, they’ve got to have mark-to-market capability for both the underlying and the hedging transactions, and they’ve got to be able to do the mark to market at least quarterly.” At the micro level, the same problems that give treasurers night sweats confound accounting systems personnel. Tracking hedge effectiveness on a quarterly basis, based on the similarity of the transaction terms and some sort of regression analysis to show historical performance, is a challenge few systems can meet. Moreover, the “other comprehensive income” (OCI) and “equity translation adjustment” accounts, which serve as holding pens for the gains or losses of effective hedges until they hit earnings, present all sorts of systems problems. Tracking when a hedge hits the OCI and when it goes to earnings is a difficult proposition. Berko offers an example of the systems complexity involved. Say you forecast that you will sell a certain number of widgets in 60 days for a certain amount of yen, and you want to hedge the forecasted transaction with a foreign exchange forward to sell those yen for dollars in 60 days, so that your net foreign exchange risk is flat. At 60 days, the forward hedge will settle. But suppose the forecasted transaction doesn’t settle on the originally forecasted settlement date, and you think it’s going to occur in another 30 days. The gain or loss on the hedge must be put into the OCI account, where it’s held until the forecasted transaction occurs. When the forecasted transaction occurs, the balance in OCI is reclassified to current earnings. If you hedge properly, there’s no earnings impact. But if the forecasted transaction’s settlement date moved 60 days or more from the originally forecasted settlement date, you automatically have to reclassify the balance in OCI to current earnings, because it violates the FAS 133 60-day cash-flow hedge rule for anticipated transactions. Either way, the system has to track all of those developments on an ongoing basis. Few vendor systems, he says, are up to the task. —R.H. According to www.fas133.com, an on-line resource center covering FAS 133 implementation issues, a FAS 133-compliant system must be able to: Link underlying exposures and hedges in individual strategies. Mark to market (or model) underlying exposures. Mark to market (or model) derivative hedges. Disaggregate mark-to-market values by type of risk (foreign exchange, interest rate, credit, etc.) and by risk component (time buckets, time value). Formally document hedges. Assess effectiveness (prospective). Measure ineffectiveness (actual). Forecast items to come out of OCI over the next 12 months. Flag type of hedge at inception (as cash-flow, fair value, etc.). Manually (or automatically) reflag type of hedge upon event. Create gain/loss accounting buckets in system (OCI and P&L). Allow users to choose a percentage of transactions hedged. Allow one-to-one, one-to-many, many-to-one and many-to-many hedge relationship designations. Accumulate mark to market in flagged accounting bucket (OCI or P&L). Re-classify gains and losses between OCI and P&L, based on event (noneffectiveness, realization). Allocate gains and losses across divisions, across time. Archive historical strategies, mark to market and historical market data time series. Prepare FAS 133 reports. Link to accounting system (direct posting of entries) and other systems. An exhaustive list indeed. According to an accompanying www.fas133.com study, only three systems out of 14 deserved to be called FAS 133-compliant as of the second quarter of 1999. An updated version of the study will be published sometime in the fourth quarter of 1999.

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