By Ted Howard
There is a lot that happened in 1994 that is still having an impact today.
It was 20 years ago this month that International Treasurer published its first issue. The goal of the newsletter, as specified in the mission statement, was “to provide you with the information and analysis you need to succeed at one of today’s most demanding corporate functions: international treasury.”
In 1994 the demands increased significantly. In the publication’s first year, derivatives debacles at Metallgesellschaft, Procter & Gamble, and Gibson Greetings (among others), were the key spurs for widespread re-examination of hedging practices by corporates and kicked off disclosure and accounting initiatives that are still being debated by treasury to this day. But it wasn’t just the specters of derivative fiascos that piqued treasury’s interest in risk management. Regulators were also drawing lines in the sand. It was 1994 when the SEC first floated proposals for public companies to disclose their use of derivatives in any meaningful detail. FASB did the same, and began honing what became the concept of hedge accounting into the headache that would become FAS133 six years later. The OCC and the G-30 were also vocal.
Despite all the chaos of those days, from International Treasurer’s first issue the editors argued that corporate treasury had to take responsibility for its own fate. And the key issue was then, as it is now, that treasury, and hedging in particular, is not a profit center. In “Lessons from Metallgesellschaft” in the inaugural March 7, 1994 issue, International Treasurer wrote, “…they presented their use of derivatives as hedges when at the end of the day they were not. Falling prey to a trader’s mentality, the company used them to build financial transactions that would not stand in the face of market elements.”
Metallgesellschaft’s case, for this reason, had treasury and boards reviewing control procedures and in some cases caused regulators to demand that companies keep a tighter rein on the hedging activities of their overseas subsidiaries. (See “German MNCs Curbing Sub Derivatives Use,” IT, March 21, 1994.) And in the case of P&G, International Treasurer argued, “Most treasurers (and CEOs) know that not all derivatives are ‘dangerous’ and can be invaluable if used properly. It is therefore in their interests to avoid feeding misperceptions and unnecessarily blaming dealers.” (“P&G and the G-30,” IT, April 18, 1994.)
Of course, one should never let a good crisis go to waste and so, like the risk-management spending that followed the 2008 financial crisis, the 1994 risk debacles were soon used as justification for spending on controls and technology—investments touted as also lowering career risk. “Treasurers can now justify the resources needed to implement better controls. It may save their jobs.” (See “A Sound Personal Investment,” IT, May 16, 1994.) While even in 1994, financial innovation was outrunning treasury’s analytical tools, the financial technology sector was charging ahead with new products to narrow the gap, such as C*ATS Software’s FiCAD. (“C*ATS and the FiCAD Generation,” IT, July 11, 1994.) Despite their worries over risk, there were still encouraging developments in the areas of regional treasury, MNC treasury centers, multi-currency loan facilities and so on.
Of course, there would be many more (and more complex) challenges in the coming years, (see chart below), but it was perhaps the issues of 1994 that prompted treasurers and boards to really begin taking those challenges more seriously.
FASB’s Dilemma
When you read through the first year of International Treasurer’s coverage of derivatives accounting issues, the howls of indignation in 1998 over the Financial Accounting Standards Board’s FAS133 Accounting for Derivative Instruments and Hedging Activities almost seem inevitable. Pushed by the GAO, Congress and regulators to force all derivatives to be accounted for at fair value in the aftermath of the 1994 losses at MG, P&G and Gibson Greetings, a move vociferously opposed by dealers and hedgers, it’s hard to see how FASB could have pleased anyone.
At the same time, the FASB found itself in early 1994 competing with a proposal from the Securities and Exchange Commission over derivatives disclosure. The SEC wanted far more disclosure that FASB did, including details of hedging strategies and expectations. Since FASB makes the rules that the SEC enforces, a public disagreement between the two bodies created confusion among market participants.
The move toward fair value accounting, except where hedge accounting effectiveness could be proven, turned out to be a tortuous process. As FASB Chairman Dennis Beresford explained, the difficulty establishing a comprehensive fair value accounting approach stems from the rapid evolution of the derivatives market. “…What was once important information becomes no longer important and vice versa.” (“Defending FASB on Derivatives,” IT, July 11, 1994.)
As FAS133 came into shape over the subsequent four years, a common complaint from the dealer community was that FASB was trying to cram an impossible one-size-fits-all set of criteria onto the derivatives markets. But as Beresford intimated back in 1994, it might simply have been impossible to have a sensible accounting regime that did not in any way constrain the fluid innovation that characterizes the OTC market.