January 13, 2020

Mr. Shayne Kuhaneck
Acting Technical Director
Financial Accounting Standards Board
401 Merritt 7, PO Box 5116
Norwalk, CT 06856-5116

Dear Mr. Kuhaneck:

PricewaterhouseCoopers LLP appreciates the opportunity to comment on the Proposed Accounting Standards Update, Derivatives and Hedging (Topic 815), Codification Improvements to Hedge Accounting.

We support the Board’s efforts to clarify the objectives and application of certain areas of the hedge accounting guidance amended by Update 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. However, we have concerns about whether the proposed guidance in Issue 1, Issue 2, and Issue 4 will provide the intended clarifications and desired improvements to hedge accounting under Topic 815.

We believe the changes proposed in Issue 1 represent a significant shift in the cash flow hedging guidance in Topic 815. As a result, this issue impacts a large portion of the guidance and a number of concepts within the literature. We believe that additional amendments are needed to address inconsistencies in the guidance with respect to both the language used and the concepts. We have included some examples in the appendix in our detailed responses to the questions.

We understand the Board’s objective to distinguish the “hedged risk” from the “forecasted transaction” in a cash flow hedge. We generally support the Board’s goal to provide greater flexibility to maintain a cash flow hedging relationship when certain changes to the designated hedged risk occur. However, we note that the proposal adds significant complexity to an accounting model that is already complex. In addition, by separating the hedged risk and the forecasted transaction into different elements of the hedge relationship with different outcomes should they change, understanding how to identify each element is essential in applying the concepts proposed. We believe that the Board should consider providing additional guidance to assist in distinguishing between these concepts.

The amendments in paragraphs 815-30-35-37A through 35-37C provide that, upon a change in the hedged risk, hedge effectiveness is only required to be assessed on a prospective basis. As a result, it would allow a hedging instrument’s gains or losses accumulated in other comprehensive income to continue to be deferred until the hedged item impacts earnings for hedge relationships that are not (and may never have been) highly effective. Under the proposed amendments, this can occur when the hedged risk changes but is still considered to be part of the broader forecasted transaction that remains probable of occurring. Accordingly, the proposed guidance would allow the effects of a cash flow hedging relationship to be reported even when a hedging instrument is not a highly effective or commercially viable hedge of the transaction that ultimately occurs. We believe this is inconsistent with the fundamental principles of Topic 815, which continue to require that a hedge has been highly effective in order to achieve income statement offset for hedging activities.

We believe the proposed guidance should require the hedge relationship to be highly effective in offsetting cash flows of the revised hedged risk on a retrospective basis. If not, we believe an entity should cease cash flow hedge accounting and treat the change in hedged risk as a missed forecasted transaction.

We support the Board’s efforts to clarify the application of the contractually specified component hedging guidance for nonfinancial items. However, we do not believe the amendments as currently proposed will provide the necessary clarity to address implementation issues that arose after the issuance of Update 2017-12. Specifically, we are concerned that the proposed guidance lacks clarity on evaluating whether certain pricing components are permitted to be hedged as a contractually specified component. We believe a better explanation is needed to evaluate what constitutes a nonfinancial asset’s “spot market” in order to assess the appropriateness of a pricing formula. For non-spot market (“forward-based”) transactions, we believe further clarification is needed to evaluate whether a contractually specified component “determines” the price of the nonfinancial asset. We recommend providing examples of when the pricing component is both allowed and disallowed from being hedged as a contractually specified component.

In addition, it appears the proposed guidance for spot market transactions is shifting to a market price convention, as opposed to a contractually specified component model. If that is the Board’s intent, we recommend explicitly articulating that within the proposed guidance.

We believe the existing terminology used to describe an instrument that is “prepayable” should be retained within the context of the shortcut guidance under Subtopic 815-20. Interpretations of this language are well known and have been consistently applied in practice following a period of interpretation and guidance provided by the Derivatives Implementation Group. We believe that changing this language to “early settlement feature” will cause confusion and potentially result in unintended consequences. If the Board has concerns about confusion with the guidance for “last-of-layer hedges,” we suggest amending the language used under the “last-of-layer” guidance as part of the project we understand the Board is already working on that will make significant amendments to this guidance.

The appendix contains our detailed responses to the Questions for Respondents, which expand on the above comments and provides additional observations for the Board’s consideration.

If you have any questions regarding our comments, please contact Chip Currie at (908) 581-4208 or David Schmid at (973) 997-0768.

Sincerely,

PricewaterhouseCoopers LLP

We have concerns about whether the proposed guidance will provide the intended clarifications and desired improvements to hedge accounting under Topic 815.

We do not support all of the proposed amendments in paragraphs 815-30-35-37A through 35-37C. Achieving cash flow hedge accounting under Subtopic 815-30 is premised on designating a hedging instrument that is highly effective in offsetting the variability of cash flows of the designated hedged item. We agree with the proposed guidance in paragraph 815-30-35-37A that requires hedge accounting to be discontinued if the hedging instrument is not expected to be highly effective at achieving offsetting cash flows attributable to the revised hedged risk on a prospective basis. However, we do not agree with the proposed guidance that permits amounts in accumulated other comprehensive income to continue to be deferred when the hedging instrument and revised hedged risk would not have been considered to have had a highly effective hedging relationship on a retrospective basis. When the hedging instrument did not serve as a highly effective or commercially viable hedge of the transaction that ultimately occurs, we do not believe that the presentation of the financial reporting effects of a cash flow hedging relationship will result in decision useful information.

We believe the proposed guidance should require the hedge relationship to be highly effective on a retrospective basis in offsetting cash flows of the revised hedged risk. If it is not, we believe an entity should cease cash flow hedge accounting and treat the change in hedged risk as a missed forecasted transaction.

We also suggest clarifying the proposed guidance in paragraph 815-20-25-3(d)(1)(vi) that requires identification of transactions that are “eligible to be identified as the hedged transaction” when they occur. It is unclear if an entity would be required to identify and document each “eligible” transaction that occurs throughout the hedge period as they occur or if an entity could wait until the end of the hedge period to identify whether the forecasted transaction occurred by looking at historical transactions that occurred throughout the hedge period.

While we support the Board’s efforts to provide greater flexibility in being able to use a substitute hedged risk in a cash flow hedge when changes occur, we believe this is a significant shift in the cash flow hedging model and additional amendments are needed to address inconsistencies in the guidance with respect to both the language and concepts. If the guidance does not require a forecasted transaction to be identified as it occurs, but instead only that it be identified as eligible to be the forecasted transaction when it occurs, this will affect all cash flow hedging relationships, not just those that experience a shortfall in transactions that have the documented hedged risk. For instance, this concept would seem to permit an entity to designate the last 15,000 units purchased or sold as a hedged item, but BC35 notes this designation is precluded.

We also believe the proposed guidance in paragraph 815-20-25-3(d)(1)(ix) regarding the requirement to document the method of identifying hedged transactions with an undocumented hedged risk needs further clarification. We recommend providing additional examples of the different types of methods of identifying hedged transactions with an undocumented hedged risk and what level of detail would be required to be included in the hedge documentation. Without understanding the Board’s intent on the type of identification methodology and documentation expected, it is also not clear how to identify what would be considered an improved identification method in accordance with paragraph 815-30-35-45A should an entity desire to change the method. It is also unclear if an entity would be precluded from applying the change in hedged risk guidance under paragraphs 815-30-35-37A through 35-37C if they do not document a method of applying hindsight in their documentation.

We recommend providing additional clarity on the proposed guidance in paragraph 815-20-25-22E(c) on evaluating whether a pricing formula “determines” the price of the nonfinancial asset in a non-spot market transaction. We believe the price component should substantively impact the price of the nonfinancial asset. Under this approach, a contractually specified component would not have substance in determining the price of the nonfinancial asset if, for example, the pricing formula always yielded a fixed price (e.g., Index A +/- difference between Index A and $7 = $7). In another example, if a pricing formula is based on Index A +/- the difference between Index A and Index B, the price of the nonfinancial asset will always be equal to the price of Index B. In these cases, we do not believe that Index A “determines” the price of the nonfinancial asset. We suggest the following edit to the proposed guidance in paragraph 815-20-25- 22E(c):

We also believe it would be helpful to include examples of pricing formulas that determine the price of the nonfinancial asset and those that do not to reduce potential diversity that may arise in interpreting the proposed guidance.

We support the Board’s intent to clarify when a contractually specified component can be hedged in a spot market transaction. However, we believe the proposed guidance on spot-market transactions in paragraph 815-20-25-22E(d) would benefit from clarifying how a nonfinancial asset’s market should be evaluated. We recommend providing some principles around how to evaluate the spot market in determining whether a pricing formula is consistent with how a nonfinancial asset is priced in its particular spot market. For example, there may be more than one market for a particular nonfinancial asset. When evaluating whether a pricing formula is consistent with a particular spot market, a spot market could be evaluated consistent with how the principal or most advantageous market is evaluated under Topic 820, Fair value measurement.

We also note that, with respect to spot market transactions, there are questions around the nature, timing, and extent of documentation that a company should obtain to demonstrate that a spot market transaction had a contractually specified component. Illustrative examples of what would be acceptable and what would be insufficient (for example, on the timing of documentation) may help address these questions.

For hedged items that are accounted for as derivatives, we do not believe gross physical settlement should be required at the contract level in order to qualify as the hedged item (paragraph 815-20-25-15B). Instead, we believe an entity should be permitted to hedge an amount relating to a portfolio of contracts accounted for as derivatives with variability in the contractually specified component designed as the hedged risk that is considered probable of being physically settled (e.g., hedging the first 100 units to occur). This would be consistent with the treatment of other hedged forecasted transactions in a cash flow hedge which do not require a probability assessment at an individual contract level.

We believe the existing terminology used to describe an instrument that is “prepayable” should be retained within the context of the shortcut guidance under Subtopic 815-20. Interpretations of this language are well known and have been consistently applied in practice following a period of interpretation and guidance provided by the Derivatives Implementation Group. We believe that changing this language to “early settlement feature” will cause confusion and potentially result in unintended consequences. If the Board has concerns about confusion with the guidance for “last-of-layer hedges,” we suggest amending the language used under the “last-of-layer” guidance as part of the project we understand the Board is already working on that will make significant amendments to this guidance.

We believe providing additional explanation will enhance operability and understandability of the proposed guidance in a number of areas.

We understand the Board’s objective to distinguish the “hedged risk” from the “forecasted transaction” in a cash flow hedge. We generally support the Board’s goal to provide greater flexibility in maintaining a cash flow hedging relationship when certain changes to the designated hedged risk occur. However, we note that the proposal adds significant complexity to an accounting model that is already complex.

One area where the proposed amendments may add complexity is the proposed guidance in paragraphs 815-30-35-37B and 35-37C, which has the potential to cause additional sequencing (or layering) issues when attempting to identify the hedged transactions. Cash flow hedging programs are often established to hedge a series of forecasted transactions (e.g., purchases of a particular commodity) that are expected to occur over a consecutive number of months (e.g., hedging purchases in August, September, October, November), with each month representing a separate and distinct hedging relationship. The proposed guidance would require entities to track transactions, both with the designated hedged risk and eligible transactions with an undocumented hedged risk, that may cross over multiple periods that are designated in separate and distinct hedging relationships. This overlap may lead to questions related to which hedge relationship a transaction should be attributed.

We recommend the Board indicate that a shortfall in transactions in one period (e.g., September) can be fulfilled with transactions that occur in a subsequent period (e.g., October) only after all of the hedged transactions for that specific period (e.g., October) have been fulfilled. That is, transactions are only eligible to fulfill a shortfall once all other forecasted transactions already designated in a separate hedging relationship have occurred. We recommend that the example in paragraphs 815-30-55-1T through 55-1V be expanded to demonstrate how the guidance would be applied in these situations. It might also be helpful to clarify that a transaction with an undocumented hedged risk can only be used to satisfy a shortfall, in accordance with paragraph 815-30-35-37C, if it is not already the designated hedged item in a separate hedging relationship.

We also believe the proposed guidance in paragraph 815-20-25-3(d)(1)(vi) may be challenging to operationalize. An entity with global operations may have “eligible” transactions that occur within a consolidated subsidiary. It may be operationally challenging if an entity is required to include its worldwide operations in its analysis. As a result, an entity may specify locations within its hedge documentation based on where delivery is anticipated.

By separating the hedged risk and the forecasted transaction into different elements of the hedge relationship with different outcomes should they change, understanding how to identify each element is essential in applying the concepts proposed. The proposed guidance in paragraphs 815-30-55-169 through 55-170 seems to indicate that location would be considered part of the forecasted transaction; consequently, location would not appear to fall within the proposed guidance in paragraphs 815-30-35- 37A through 35-37C for addressing changes in the hedged risk. However, we understand that the Board may have intended to permit flexibility in cash flow hedges if the delivery location changed (for example more natural gas is delivered to Plant A as opposed to Plant B due to changes in production location). If location can never be considered part of the hedged risk, we believe the Board should clarify why the proposed guidance on changes in location is viewed differently than the proposed guidance on changes in the designated hedged risk. Specifically, we believe the Board should clarify its intent behind the proposed guidance in paragraph 815-30-55-170, as it seems inconsistent with how the Board is treating a change in the designated hedged risk (including the ability to change from 12 individual one month hedges of interest rates to two 6-month hedges).

Yes, we believe the Board should consider the following additional clarifications:

We are not aware of any special considerations.

As previously noted, we do not believe the Board's proposed guidance is sufficiently clear as to what should be documented at hedge inception as it relates to using hindsight. We believe that an entity should document at hedge inception a methodology to identify hedged forecasted transactions using hindsight if the use of hindsight will be permitted. We also believe that this methodology should be consistently applied and, consistent with paragraph 815-30-35-45A, any changes to the methodology would require discontinuance of the existing hedge relationship.

It does not appear that Update 2017-12 explicitly excluded foreign currency risk and credit risk from the change in hedged risk guidance. Therefore, we believe the Board should include transition guidance for entities that may have applied the change in hedged risk guidance to hedges of foreign currency risk or credit risk.

We generally agree with the proposed transition requirements.

We believe it would be helpful if the Board included in the guidance the types of hedge relationships that may require rebalancing by increasing or decreasing the designated notional of the hedging instrument provided by the proposed guidance in paragraph 815-20-65-6(e).

We believe the changes proposed in Issue 1 represent a significant shift in the cash flow hedging guidance in Topic 815, which may require more time to implement. However, we note that this question is best addressed by financial statement preparers.