Prepared Testimony of Subcommittee Chairman Phil Gramm (R-TX)

Hearing on Derivative Accounting Rules

March 4, 1997


Let me state briefly my concern, and the concern of this Subcommittee, about financial derivatives and the new Securities and Exchange Commission (SEC) regulations and proposed Financial Accounting Standards Board (FASB) rules concerning the accounting treatment of derivatives. I am concerned that the rules that have been imposed by the SEC and proposed by FASB will induce firms to use derivatives less. If that decision is made for business and economic reasons, that is fine. To the degree that companies are driven by accounting rules to avoid derivatives, which otherwise would help them deal with risk, that will harm them as profit-making institutions, and will harm the economy.

If companies are using derivatives, they must believe that they are obtaining risk reduction services from that use. To the degree that these disclosure requirements induce them to reduce their use of derivatives, we are inhibiting a new innovation in risk management. The result is that risk faced by our companies is unnecessarily greater, artificially greater, and in the end losses will be greater and profits lower. That harms the companies and the millions of people who invest in them.

Second, I am very concerned about the proposed disclosure requirements creating a false impression. In that context, it is interesting that the regulators have chosen to focus on derivatives and not chosen the many other risks that companies face, risks that include everything from exchange rates to the cost of principal inputs. If we single out possible risk from exposure to financial derivatives, and require that it be disclosed publicly, without including every item that generates risk, what we do is show what steps that the company is taking to try to deal with the risks they face without giving balanced information, information about the underlying risks that a derivative instrument may be intended to reduce.

I am also moved by the argument that is made by those who say that requiring this disclosure gives away proprietary information. It tells competitors a tremendous amount about the operations of the company and what the expectations of the company are and what its risk planning is.

Finally, having reviewed the SEC's cost and benefit evaluation, I am unimpressed. I think a large part of it is simply boilerplate. And while I have been asked not to quote from the few comments that are actually made by economists at the Securities and Exchange Commission, I think that their one source of detailed analysis shows how much the analysis conducted by the Commission overall was not well done, was not well thought out.

My purpose today is to try to begin a public discussion of the problems involved with these accounting proposals, to get on the record the views of the Securities and Exchange Commission, particularly their views in response to the views of those who have commented on the proposals. I think we have a balanced panel today, reflective of the opinions of those who favor these rules and those who oppose them.

In response to these proposals, there are many directions that the Committee could take. There are those who believe that we have the ability to go back and overturn this regulation under the provisions of the Congressional Review Act. We certainly have the ability to make law. I am holding the hearing today because I have not reached a conclusion on any of these approaches, and I thought that this hearing would be advantageous to me and to the Committee and to those few people in the public who, (A), know what derivatives are and, (B), care.

I am sensitive to this, because there is almost a mythology that has been built up with regard to derivatives. And it seems to me that this is something we need to be very careful about.

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