Improving the FASB's Requirements for Off-Balance-Sheet Market Risk Disclosures

Abstract

This paper discusses the requirements and limitations associated with SFAS No. 105 market risk disclosures, empirically examines the current implementation of SFAS No. 105 in the financial disclosures of financial institutions, and proposes improvements to the market risk disclosures presently required by the FASB. The results of the empirical analysis of 35 large U.S. financial institutions show that (1) many firms indicated a concern that statement users are not able to clearly distinguish between required contract dollar amount disclosures and actual risks; (2) although most firms use instruments with OBS risk for proprietary hedging and trading, no firm provides a useful detailed breakdown of the degree of risk attributable to these different activities; (3) the greatest conformity in reporting occurs in those firms with the largest contract dollar volume (in absolute terms and as a percent of equity); and (4) very few firms take any initiative in the reporting of additional disclosures. In light of these findings, this paper proposes a new method of market risk disclosure that is based on the margin required by exchanges and their Clearing Corporations. Margin disclosure is shown to be superior to SFAS No. 105 requirements in that it (1) directly correlates with the true risk of a firm's position, (2) is based on the entire financial position of a firm, (3) is easily obtained for even the most complex financial positions, (4) is dynamic in response to changing market conditions, (5) is determined by an independent third party whose main interest is the measurement of market risk, and (6) is a numeric rather than descriptive measure.