Burn These Rules

While U.S. companies have fallen victim to restatements over derivative accounting rules, life has not been much easier in Europe. In recognition of the onerous, and frankly unnecessary, burden that FAS 133 and IAS 39 impose on companies, I have come up with 10 reasons to hate the rules on both sides of the Atlantic, which hopefully willserve as a list of reasons for regulators to address the accounting malaise caused by these irritatingly complex standards.1. Both FAS 133 and IAS 39 compel new investments in highly specialized staff and solutions–or significant spending on consultants that offer the same skill set and hosted solutions.2. Both rules can cause artificial income statement volatility as changes in the market value of derivatives deemed ineffective would immediately hit earnings and hold the potential of shocking income surprises.3. The rules can cause artificial balance sheet volatility since changes in market value even on derivatives deemed effective can make an entity look substantially more or less leveraged than it is.4. The rules can lead to the dismissal of highly qualified employees over large derivative-induced losses or excessive vol- atility, which can be occurring even when the hedges are working well from an economic/risk management viewpoint.5. The rules can entrap companies into simple, potentially economically inferior, plain-vanilla hedges, which have been afforded favorable accounting treatment that portends less artificial earnings volatility–even in situations where sophisticated hedges are called for–and can even force companies to unwind hedges that have been delivering superior economic results.6. The rules can force senior risk managers to place compliance with accounting rules over economic risk and above a company’s performance concerns.7. The rules, which are excruciatingly difficult to implement, expose companies to the unnecessary risk of making technical mistakes that will lead to restatements.8. They expose the company–and then, of course, investors as well–to new risks that they cannot possibly anticipate since the market value of derivatives can change for reasons that are ridiculously unrelated to the real activities of a non-financial company.9. One of the most egregious problems with the rules is that no one–including the regulators–seems to know how they work. Particularly in the U.S., the rules have been subject to several bouts of redefinition. And despite regulator claims that these are all clarifications and not changes, the Financial Accounting Standards Board has felt the need to clarify more times than is acceptable for any rule.10. And finally, we come to the most obvious and probably the most important reason to hate these rules: They do not necessarily do any good, while creating lots of trouble. In fact, from what we know, it is doubtful that either enhances corporate risk management to any extent, and disclosure and transparency are certainly not enhanced at all.