-182-
first-order economic risks. Many of these hedging transactions,
such as exchange-traded futures contracts, have maturities that
are much shorter than the long-term swaps contracts on a swaps
dealer’s books, and other hedging transactions (e.g., a long
position in physical securities) are regularly liquidated or
unwound as new customer swaps change the risk profile of a swaps
dealer’s book.
Traditional accrual method accounting, which uses the
realization principle as the bedrock of its income inclusion
rules, can subject a swaps dealer to enormous and unpredictable
distortions in the measurement of its income from its book of
customer swaps and hedges. The dealer’s recognized losses on
short-dated hedges, for example, would offset its unrealized
gains on its customer swaps as a commercial and economic matter.
The unrealized gain, however, would be ignored for tax purposes.
The only practical way to eliminate these large and
unpredictable timing distortions arising from a book of
short-dated hedges and long-dated customer contracts is to adopt
a mark-to-market method of tax accounting. Through the
recognition of all economic fluctuations in value in the swaps
dealer’s book of customer positions and hedges, a mark-to-market
method assures that a dealer is taxed each year on its true
annual change in net worth arising from its dealer activities.
In fact, many swaps dealers had been advocates of comprehensive
Page: Previous 172 173 174 175 176 177 178 179 180 181 182 183 184 185 186 187 188 189 190 191 NextLast modified: May 25, 2011