A proposed accounting standard will reduce the number of government-issued derivatives that qualify as effective hedges and receive special accounting treatment. Municipalities are entering swaps referenced to LIBOR because it's a more liquid market than The Bond Market Association swaps, but the increase in the number of government bodies following this strategy has led the Governmental Accounting Standards Board to question the relationship between the government rates these issuers pay versus the taxable rates in the swaps, explained Randal Finden, a project manager with GASB in Norwalk, Conn. "How much can they vary before one would have to believe the hedge is no longer effective?" Finden asked. A GASB working group will present its proposals to the board on April 5 and a published standard is expected by year-end.
The working group is currently determining how far the two rates can diverge before the deal no longer qualifies for special accounting treatment. Hedge accounting means the gains and losses of the derivative can be offset against the liability rather than accounted for at fair value and passed through to the income statement.
The group is considering limiting special accounting treatment to those derivatives whose rates are within a 50 basis point range. Regression is also being discussed where effective hedges are those that come up with a figure of correlation around 0.8 or better.
"Because so many municipal issuers are using LIBOR and not BMA, trading volumes in BMA had decreased significantly and that part of the market has become less liquid," according to Peter Shapiro, a managing director with Swap Financial Group in South Orange, N.J.
