The Economics of Disclosure Requirements for Derivatives

Two proposals currently crossing the desks of policymakers are viewed by some market participants as a direct response to the highly publicized derivatives-related losses of the last few years. The Securities and Exchange Commission (SEC) is currently reviewing responses to its proposal on the disclosure requirements of accounting policies and market risk for derivatives. This proposal specifies the rules that firms should follow in disclosing the derivatives they use and why, the risks are associated with these instruments and the accounting treatment for these instruments and how it affects the accounting statements of the firm. At the same time, the Financial Accounting Standards Board (FASB) has proposed a set of accounting standards for derivatives used for hedging and risk management. The proposal provides definitions of financial contracts that qualify as derivative instruments, explains which types of transactions involving the use of derivatives qualify for hedge accounting, and specifies the accounting procedures that need to be followed with respect to these instruments.