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ISDA Stumps for GAAP's Netting for Derivatives

Tammy Whitehouse | June 1, 2012

International accounting rules could take a tip from the U.S. rule book when it comes to netting derivatives -- at least in the view of the International Swaps and Derivatives Association.

ISDA published a paper to explain how and why U.S. Generally Accepted Accounting Principles and International Financial Reporting Standards differ in their treatment of derivatives. The paper notes that terms like netting, offsetting and set-off are used to express the same basic notion, but represent very different concepts. U.S. GAAP generally provides more allowance for entities to present their derivative positions on a net vs. gross basis than IFRS, the paper says. The Financial Accounting Standards Board and the International Accounting Standards Board are working on a comprehensive standard to address all financial instrument accounting, including hedging.

“ISDA believes that net presentation, in accordance with US GAAP, provides the most faithful representation of an entity's financial position, solvency, and exposure to credit and liquidity risk,” ISDA said in a statement. “Individual derivative transactions that are subject to enforceable master netting agreements should be eligible for netting in the balance sheet.” The association reasons that netting provides the best view of an entity's resources and claims and provides the most useful information for investment decisions.

The paper explains why netting and offsetting are such big issues for entities, especially financial institutions, that are heavily involved with hedging. It also explains the differences between securities, loans and receivables, and derivatives, and it addresses portfolio management, the swap markets, and other critical issues.