Big U.S. banks oppose derivatives accounting plan

Fri May 6, 2011 11:33am EDT

* U.S. derivatives accounting at odds with foreign rules

* Some bank balance sheets could nearly double

* Changes on FASB's board cloud proposal's future

By Dena Aubin

NEW YORK, May 6 (Reuters) - Wall Street's biggest banks are urging rule-makers to scrap a derivative accounting proposal that could inflate their balance sheets by trillions of dollars.

The draft rules, unveiled by the Financial Accounting Standards Board in January, would force banks to report their full exposure for most derivatives on their balance sheets, instead of net amounts.

In a worst-case scenario, S&P 500 companies might have to bring nearly $7 trillion in derivatives onto their balance sheets if no netting is allowed, according to a report by Credit Suisse.

About 97 percent of that would come from five big banks: Bank of America Corp (BAC.N), JP Morgan Chase & Co (JPM.N), Citigroup Inc (C.N), Goldman Sachs Group Inc (GS.N) and Morgan Stanley (MS.N), according to the report. Derivatives are a big source of revenue for banks.

The proposed rules are meant to harmonize U.S. accounting standards with their international counterparts. But with new board members at FASB, the future of the proposal is uncertain.

In letters to FASB, banks complained that the change would exaggerate risks. In practice, banks typically have legal agreements in place that allow them to net, or offset their derivative positions against one another, so they are not exposed to losses on gross amounts, banks said.

"The flawed offsetting model in the exposure draft will either obscure or create nonexistent risks which will ultimately mislead financial statement users," Robert Traficanti, deputy controller at Citigroup, wrote last week.

The accounting proposal could also make it hard to net derivatives traded on clearinghouses, banks complained. One requirement for netting is that derivatives be settled simultaneously; but on a clearinghouse, derivatives are often settled in batches throughout the day.

"There is certainly concern right now about how those rules are written, and justly because there are significant implications," said Lisa Filomia-Atkas, a partner at Ernst & Young.

U.S., INTERNATIONAL RULES AT ODDS

Derivatives have come under scrutiny by regulators worldwide since the global financial crisis. Many investors complain that banks' exposures are opaque, making it difficult to determine exactly how safe a lender is.

Accounting treatment for derivatives differs sharply, with netting allowed for most derivatives in the United States but not under International Financial Reporting Standards.

Leaders of the top 20 world economies have been pushing rule-makers to iron out accounting differences.

The proposed rewrite, a joint effort of FASB and the International Accounting Standards Board, would restrict netting to limited circumstances.

"It certainly will be very onerous to meet all the netting requirements in the proposal," said Olu Sonola, director of credit policy at Fitch Ratings. "In its current form, the bar is very high."

The American Bankers Association, a lobbying group, argued that banking analysts rarely use gross amounts to figure out a company's risks. Balance sheets should report the net information, with gross amounts in footnotes, it said.

Some accounting experts, however, said it is important to see the total derivative amount on the balance sheet.

"Netting just doesn't give you a fair representation of what the company's full asset and liability exposure is," said Charles Mulford, accounting professor at Georgia Institute of Technology.

Changes on FASB's board have clouded the future of the proposed rule, which passed by a 3-2 vote. Former FASB Chairman Robert Herz, who voted for it, has resigned and been replaced as chair by Leslie Seidman, who opposed it. The board also has three new members, "so anything could happen," Fitch's Sonola said. (Reporting by Dena Aubin; editing by John Wallace)

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