Corporate Governance

Investors Welcome New Disclosure Rules for Banks and Other Sellers of Credit Derivatives

By Carol Straw

Last week, the Financial Accounting Standards Board (FASB) adopted new rules for banks and other purveyors of credit derivatives to help investors get a better read on these financial instruments. For companies with calendar year-ends, the decision leaves them with about four months to digest and comply with the revisions made to FAS 133 and FIN 145, two rules that address how companies account for and disclose information about hedging activity.

In the wake of the current credit crisis, bond defaults rose precipitously, surprising even default swap sellers. As a result, some sellers were left with obligations that depleted or severely hampered their cash positions and weakened their credit ratings. The existing disclosure requirements, in turn, failed to adequately address these seller?s credit risk, financial strength and performance.

Specifically, the new rules proscribe for every derivative ? or group of similar derivatives ? the seller must disclose the nature of the instrument (term, reasons for entering into the contract, and current status of the payment/performance risk); the maximum potential amount of future payments the seller is required to make the under the contract terms; the fair value of the derivative; and the nature of any recourse provisions that would allow the seller to recover the amount it pays out ? such as collateral pledged or assets held by third parties that the seller has the right to liquidate.

The growth of credit defaults swaps has been phenomenal over the last three years. According to ISDA (International Swaps and Derivatives Association), the notional value of credit-default-swap contracts rose to $62.2 trillion by the end of 2007, up from $34.4 trillion in 2006 and $17.1 trillion the year before.

Full post as published by PomTalk on August 19, 2008 (boomark / email).