FASB Expands Fair Value Hedge Accounting Guidance

In March 2022, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2022-01, Derivatives and Hedging (Topic 815): Fair Value Hedging – Portfolio Layer Method. The new standard amends guidance previously issued under ASU 2017-12 related to fair value hedging of interest rate risk for portfolios of financial assets. While the FASB’s intent in issuing ASU 2017-12 was to simplify hedge accounting and to better align entities’ financial reporting with their risk management activities, the standard fell short in the eyes of certain stakeholders. The objective of ASU 2022-01 is to address these shortcomings.

ASU 2017-12 Refresher

To understand why the FASB issued ASU 2022-01, some context is helpful. Prior to the issuance of ASU 2017-12, stakeholders expressed concern that the accounting standards did not allow entities to recognize the economic results of their hedging strategies in the financial statements. Stakeholders also felt as though the effects of hedge accounting on financial reporting were difficult to understand and interpret, and that reported results should allow users of the financial statements to better understand the risks to which an entity is exposed and the strategies used by the entity to manage such exposures.

To address these concerns, the FASB issued ASU 2017-12 with the intention of improving the portrayal of the economic results of an entity’s risk management activities in its financial statements. While the amendments in the standard are many, one of the more significant changes was the introduction of a portfolio hedge of prepayable assets, known as the “last-of-layer” method, which allowed entities to fair value hedge the portion of a closed portfolio of prepayable assets (or one or more beneficial interests secured by a portfolio of prepayable financial instruments) expected to be outstanding for the designated hedge period. If the requirements for the last-of-layer method are met, prepayment risk would not need to be incorporated into the measurement of the hedged item.

While the amendments under ASU 2017-12 were generally viewed as improvements over earlier guidance, stakeholders raised concerns that limiting hedge accounting to a single layer of a closed portfolio was inconsistent with entities’ risk management activities. Stakeholders also noted that, because uncertainty can exist in the cash flows of prepayable and nonprepayable financial assets, nonprepayable financial assets should also be eligible to be included in the closed portfolio being hedged. Finally, stakeholders requested more guidance on how to account for the fair value hedge basis adjustment associated with last-of-layer hedges.

The New Standard

Enter ASU 2022-01, issued in the hopes of addressing stakeholders’ requests to further improve hedge accounting guidance following the issuance of ASU 2017-12. The standard amends current hedge accounting guidance in several areas, the key aspects of which are as follows:

Ability to hedge multiple layers of a single closed portfolio vs. a single layer under the new standard, entities have the ability to hedge multiple layers of a single closed portfolio in contrast with the current last-of-layer method discussed above. Now referred to as the “portfolio layer” method, this expanded approach allows entities to achieve hedge accounting for hedges of a greater proportion of interest rate risk within a given closed portfolio.

Inclusion of nonprepayable financial assets – as noted above, one of the concerns about current guidance raised by stakeholders was the inability to include nonprepayable financial assets within a hedged closed portfolio. The new standard addresses this concern.

Additional flexibility to achieve hedge accountingunder the new standard, entities will have a greater ability to apply various layering techniques (e.g. spot-starting and/or forward-starting swaps) to multiple hedged layers. This added flexibility will allow entities to use derivatives and structures that best align with their circumstances.

Hedge basis adjustmentsthe new standard provides additional guidance on the accounting for and disclosure of hedge basis adjustments that apply to the portfolio layer method, including:

  1. A requirement to maintain basis adjustments in an existing hedge on a closed portfolio basis rather than allocating them to individual assets;
  2. A requirement to immediately recognize and present the basis adjustment associated with the amount of a breached dedesignated layer in interest income;
  3. A requirement to disclose the total amount of basis adjustments in existing hedges as a reconciling amount if other areas of Generally Accepted Accounting Principles (GAAP) require the disaggregated disclosure of the amortized cost basis of assets included in the closed portfolio; and
  4. A prohibition from considering basis adjustment in an existing hedge when determining credit losses.

To illustrate some of these changes, let’s consider a financial institution that identifies a closed portfolio of $100 million in loans for which it would like to hedge the interest rate risk. Let’s further assume that the institution expects $75 million of the closed portfolio of loans to remain outstanding for at least five years and $25 million to remain outstanding for at least ten years.

Under pre-ASU 2022-01 guidance, the total amount of the closed portfolio the institution would be able to hedge would be limited to either $75 million for five years or $25 million for ten years. With the introduction of multiple hedged layers under the new standard, the institution has added flexibility in how it hedges this closed portfolio. The institution could, for example, use a spot-starting swap to hedge a $50 million layer ($75 million – $25 million) for five years and another spot-starting swap with a ten-year term to hedge the $25 million layer expected to remain outstanding for at least ten years. Alternatively, the institution could elect to use a five-year spot-starting swap to hedge the $75 million layer expected to remain outstanding for at least five years and a five-year forward-starting swap to hedge a $25 million layer for years six through ten.

Final Thoughts

As benchmark interest rates change over the term of their financial assets, entities are looking to ensure they are not overly exposed to interest rate risk. The additional flexibility afforded by this new standard may make it an attractive option for entities looking to reduce their risk – even those that have historically shied away from the use of derivatives. That said, derivatives may not be for everyone, and entities considering them must ensure they understand the accounting and reporting implications, as well as the risks associated with their use.


For public business entities, the amendments in ASU 2022-01 are effective for fiscal years beginning after December 15, 2022, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years. Early adoption is permitted for entities that have adopted ASU 2017-12.

Upon adoption, entities may designate multiple hedged layers of a single closed portfolio on a prospective basis. Guidance related to hedge basis adjustments (with the exception of the related disclosure requirements) is to be applied on a modified retrospective basis through a cumulative-effect adjustment to the opening balance of retained earnings on the date of initial application. Entities have the option to apply disclosure-related amendments prospectively or retrospectively.

The standard also allows entities to reclassify debt securities from held-to-maturity to available-for-sale if they are included in a closed portfolio that is hedged using the portfolio layer method. Entities have 30 days from the date of adoption to reclassify such securities and include them in a closed portfolio, or portfolios, designated in a portfolio layer method hedge.


For more information, please contact Joseph Jalbert, or your BNN advisor.

Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.