NAREIT Comments on Proposed Statement Amending Financial Accounting Standard No. 133

April 3, 2000

Mr. Timothy S. Lucas
Director of Research and Technical Activities
Financial Accounting Standards Board
File Reference No. 207-A
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116


RE:       Proposed Statement Amending Financial Accounting Standard No. 133


Dear Mr. Lucas:


The National Association of Real Estate Investment Trusts® (NAREIT) is pleased to have the opportunity to provide the Financial Accounting Standards Board comments on the proposed statement of financial accounting standards, "Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment to FASB Statement No. 133." As you know, NAREIT is the national trade association for REITs and publicly traded real estate companies. Members include real estate investment trusts (REITs) and other businesses that own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service these businesses.


NAREIT applauds the FASB's faithful allegiance to due process-welcoming private industry participation in the development of financial reporting standards. We recognize that this is a difficult, labor-intensive, and time-consuming process for all FASB members, staff and for the many participants of special task forces who have generously volunteered their time to this process. Standards governing the highly complex area of derivative instruments and hedging activities have necessarily required more time and effort than most other accounting standards. As an industry that relies regularly on hedging transactions, we are grateful to the Board and staff for their willingness to incorporate recommendations from industry participation, and for their continued dedication to producing a standard that reports the economic activity of these transactions and that can be implemented with the least degree of difficulty.


NAREIT supports the Board's proposals to amend Statement 133 for the normal purchases and normal sales exception; hedging the benchmark interest rate; hedging recognized foreign currency denominated debt instruments; and hedging with intercompany derivatives. However, we believe that the Board's unwillingness to amend the issue of partial term hedges creates problems for the real estate industry. We are also concerned about the practical limitations that real estate companies will endure under the Derivative Implementation Group's current thinking about discontinuation of cash flow hedges.


Normal Purchases and Normal Sales
The accounting provisions of SFAS No. 133 do not apply when purchases and sales contracts have no net settlement provisions or no market mechanism to facilitate net settlement, and when the purchase and sale is for something other than a financial instrument or derivative instrument. The proposed amendment expands this exception to include purchase orders for which physical delivery is expected, even though net settlement provisions and market mechanisms for net settlement exist. NAREIT supports the Board's position to not require contracts that require physical delivery of non-financial assets to be accounted for as derivative instruments under SFAS No. 133.


Hedging the Benchmark Interest Rate
NAREIT strongly supports the Board's proposed amendments permitting the benchmark interest rate to be designated as the hedged risk in a hedge of interest rate risk. However, we believe that the Board's understanding of market interest rate, including risk free, sector and credit spreads, is not always consistent with the market interest rate risk that gives rise to hedging transactions. Hedging the market interest rate in accordance with the existing definition of SFAS No. 133 creates ineffectiveness because hedging instruments that are used commonly by real estate companies are valued using benchmark rates. For example, real estate companies that hedge interest rate risk usually look to the type of indebtedness to determine the hedged risk. Under current market conditions, these are typically liabilities in which the benchmark is either the U.S. Treasury or LIBOR. This proposed amendment would result in real estate companies most often designating the benchmark rates as the hedged risk.


The Board also considered whether other rates in the U.S. financial markets meet the definition of benchmark interest rates and whether those rates should be permitted to be designated as the hedged risk in a hedge of interest rate risk. Also important to the real estate industry is hedging the benchmark rate for tax-exempt bond offerings-a form of financing often used by real estate companies. The derivative instruments that are commonly used to hedge tax-exempt offerings are based on the Bond Market Association (BMA) Index. This index trades as a percentage (usually 60 percent) of the U.S. Treasury rate, but not at a constant percentage because of changes in corporate tax rates. NAREIT urges the Board to interpret the amendment to include other indices in order to conform accounting standards to customary practices in the industry. In the immediate term, we seek some clarification of the proposed amendment and how it would apply to the growing municipal securities market. Hedging instruments are formulated expressly for those tax-exempt instruments and must be relied upon to achieve full effectiveness under the requirements of SFAS No. 133.


NAREIT supports the Board's development of amendment language concerning the risk that is being hedged so that the standard is flexible enough to withstand potential future developments in financial markets. We believe that companies should have flexibility in identifying the risk that is being hedged. Using the required policy statement and the accounting designations required at the onset of each and every hedge, companies can explain the hedged risk, whether it be market interest rate risk, as described in the original draft of the standard with its three components, or risk as measured by the benchmark component of a hedged asset or liability.


Hedging Recognized Foreign Currency Denominated Debt Instruments
The current standard precludes hedge accounting for assets or liabilities that are denominated in a foreign currency and remeasured into a functional currency. The general principle that disallows hedge accounting is that the foreign currency translation under SFAS No. 52 already is reported in earnings. With this proposed amendment, the Board is allowing an exception to the general principle and is permitting fair value and cash flow hedges of foreign currency denominated debt instruments. NAREIT agrees with the proposed amendment because of the anticipated problems that result when the hedged asset or liability is measured at fair value using the spot exchange rates, and the fair value on the hedging instrument that is based on forward rates.


Hedging with Intercompany Derivatives
NAREIT is pleased that the Board has recognized the operational problems that occur when a member of a consolidated group only can qualify as a foreign currency hedging instrument in the consolidated statements when that member has entered into an individual offsetting derivative contract with an unrelated third party. NAREIT supports the proposed changes that permit derivative instruments entered into with a member of the consolidated group to qualify as hedging instruments on a consolidated basis so long as those derivatives are offset by unrelated third party contracts on a net basis.


Partial Term Hedges
NAREIT strongly urges the FASB to reconsider the decisions of the Derivatives Implementation Group to prohibit partial-term hedges. We believe that the work submitted by John Smith of Deloitte & Touche best illustrates how a partial-term hedge can be effective in offsetting a change in fair value relating to the portion of the yield curve. Hedging results can be quantified objectively and reliably without a hypothetical non-existent principal payment before maturity. We also believe that paragraph 21a(2)(c) should be amended to allow partial term hedging of a portion of selected cash flows.


Discontinuation of Cash Flow Hedges
The Board has also proposed amendments to the implementation guidance with respect to the time allowance beyond the initial time frame of a forecasted transaction when a derivative contract would no longer qualify for hedge accounting. Under the new implementation guidance, the Board believes that a two-month window is an adequate time frame for which a transaction could transpire and still obtain hedge accounting. NAREIT strongly disagrees. From the time in which a hedge of a forecasted transaction is initially undertaken, a real estate company may have to work with public and neighborhood groups, obtain permits and licenses from a municipality, and construct a building. Each of these items introduces potentially substantial hurdles and time-consuming projects that usually delay the process. Real estate companies can forecast many of these factors, but there is limited control over the time frame of the final financing. To resolve this concern, NAREIT asks the Board to identify specifically these types of unforeseen circumstances that would allow real estate companies to extend hedges beyond the proposed two-month time frame.


NAREIT appreciates the opportunity to comment on this important accounting standard. Should any member of the Board or staff have questions about the our comments, please contact me at (484) 530-1888, Marti Tirinnanzi, from Chatham Financial Corp. and Chair of NAREIT's Derivatives and Hedging Task Force at (202) 965-1882, or David Taube, NAREIT's Director of Financial Standards at (202) 739-9442.






Timothy A. Peterson
Executive Vice President and Chief Financial Officer, Keystone Property Trust
Co-Chair, NAREIT Accounting Committee