SAS skirmish

The planned implementation of a new accounting standard in July is set to transform the way Singapore companies treat derivatives on their balance sheets. But as the deadline looms, it appears that few firms are aware of the extent of the legislation.
The Statement of Accounting Standard 33 (SAS 33), which is comparable to the IAS 39 standard issued by the International Accounting Standards Committee, compels all Singapore companies that hold derivatives – including financial institutions – to demonstrate their effectiveness as hedging instruments, or include the derivative positions as profits or losses on their balance sheets. To qualify for hedge accounting, the hedge must prove to be “highly effective” at offsetting gains or losses on a hedged item, according to The Institute of Certified Public Accountants of Singapore, which published the document last July. An effective hedge is classified as one that almost fully offsets the changes in the fair-value of the hedged item within a range of 80%-125%.

Chua Kim Chiu, PwC: “Time is running out very fast”

To accomplish this, companies must mark-to-market all their hedges with the corresponding hedged items, formulate concise risk management strategies and devise effectiveness tests for the hedges. What’s more, the firms have to prove the hedges are effective both at inception and on an ongoing basis, an extensive workload for risk management executives.
The Singapore financial year runs from January to December, so although the legislation is effective on 1 July this year, in reality banks will not have to report using the new standard until December 31 2002.
However, according to David Belmont, a Singapore-based director of financial and commodity risk practice at Arthur Andersen, a number of Singapore institutions are unaware of the vast swathe of data needed to comply with SAS 33. They should start preparing for implementation now.
“Banks and other firms really do need to focus on the challenge to get ready,” he says. “All firms have to produce a lot of documentation before the end of 2002 to show that when the derivatives were initially purchased, they were purchased for the purpose of a hedge and at the time they were purchased that the correlation was strong. You have to then show that the hedge relationship continues to hold. If it doesn’t continue to hold, you can’t continue to account for it under hedge accounting.”
Chua Kim Chiu, head of the financial services industry and a partner at
PricewaterhouseCoopers in Singapore, agrees that SAS 33 will be a big change for a number of institutions in Singapore, and notes that a lot of work needs to be done before the reporting period begins.
“I think [Singapore companies] are broadly aware of [SAS 33], but they have not been fully appreciative of the extent of the issues,” he says. “I think if they work hard on this, they should be okay by January 1 2002, but time is running out very fast.”
Chua notes that many companies will need to invest in or modify existing risk management systems to comply with the standard, pointing out that the systems need to be capable of establishing a clear link between the hedged item and hedging instrument to qualify for hedge accounting. “If you buy new systems, there will be some costs involved. But I don’t believe that the cost is prohibitive,” he adds.
However, the hedge must relate to a specific designated risk rather than overall business risk. Chua points out that this could potentially lead to greater levels of risk as companies shy away from purchasing complex derivatives without a specified hedge item.
In addition, with fewer derivatives likely to qualify for hedge accounting, the company’s share price could experience greater volatility due to the fluctuations in fair value of the derivatives now marked to market and reported on the balance sheet.
“It is going to narrow down what derivative positions you can count for hedge accounting,” says Belmont. “You are not going to be able to accrue gains or losses on as many positions as you used to be able to. Consequently, you are going to have to mark-to-market those positions now and that will likely lead to more volatility of income for the banks that have derivative positions.”