Most credit derivatives do not qualify for hedge accounting treatment, implying greater earnings volatility if the hedged portfolio or securities are carried at historic cost in their banking book. As a bank supervisor, I am concerned if the accounting treatment discourages the use of new risk-management financial instruments. You may be wondering if the answer to this volatility issue is fair value accounting.
If the hedged asset were measured at fair value, the changes in values of the hedged item and the credit derivative would offset each other, reducing the volatility that arises when only the derivative is marked to market, depending of course on the effectiveness of the hedge.