DIVERGENT FAS-133 AND IAS-39 INTEREST RATE RISK HEDGE EFFECTIVENESS: PROBLEM AND REMEDIES

Abstract

Generally, it is presumed that an interest rate swap hedge of fixed income assets and liabilities will be 100% effective. Specifically, SFAS-133.68 actualizes this effectiveness through its short-cut method (SCM) interest rate risk hedge specification. We show that this presumption is false. This negative finding leads to a severe IAS-39 implementation problem because IAS-39 explicitly precludes the SCM. Furthermore, this problem has major implications for bank (and insurance) capital requirements. We specify a series of remedies for this problem. We believe that the best remedy falls in the fine print of IAS-39.F.5.5 guidance. In this guidance, a "theoretical swap" hedge effectiveness method, (B), effectively, provides FAS-133 SCM treatment for analogous IAS-39 interest rate risk hedges.