20 December 2012

ESMA's statement on forbearance practices in IFRS financial statements of financial institutions

ESMA would like to stress the need for transparency and the importance of appropriate and consistent application of the recognition, measurement and disclosure principles provided within IFRS in order to ensure the proper functioning of financial markets.

Therefore financial institutions and their auditors should take this Public Statement into due consideration with regard to exposure and the effect of forbearance related practices, when preparing or auditing IFRS financial statements for the year ending 31 December 2012.

As a result of the financial and economic crisis, there has been increased interest by investors and other market participants in credit risk exposures and impairment recognised for financial assets, in particular on the forbearance practices that financial institutions extend towards their borrowers.  This interest reflects the need for transparency and accuracy in financial information, as markets need to be confident that the financial statements of issuers accurately reflect credit risk exposures and the credit quality of their financial assets.

ESMA, based on the EDTF’s concerns, has decided to focus on activities that promote consistent treatment of forbearance-related practices in IFRS financial statements.  Consistent use of impairment principles and enhanced transparency on forbearance practices, and their effect on the presentation of impaired assets, promotes comparability among the financial statements of financial institutions.  ESMA notes that if the credit risk of an asset changes to the extent that losses are incurred, IFRS requires the recognition of impairment losses, whether or not the assets are subject to forbearance measures.  Forbearance should not lead to avoiding or postponing the recognition of impairment or obscuring the level of credit risk resulting from forborn assets.

ESMA, together with national enforcers, conducted a limited fact-finding exercise on the accounting treatment relating to forbearance practices in the 2011 annual IFRS financial statements of a sample of financial institutions listed on regulated markets in the European Economic Area.  On this basis, ESMA noted that disclosures about forbearance practices in the financial statements diverged significantly and were often limited in the amount of information provided and vague as to content.  ESMA found that in some cases it was unclear whether forbearance measures were considered objective evidence of impairment and whether, and to what extent, the need for forbearance led to recognition of impairment losses. 

The results of the fact-finding exercise also indicated that issuers consider a number of different practices are caught under the umbrella of forbearance measures.

Forbearance and objective evidence of impairment

ESMA is of the view that the indicators of objective evidence of impairment in IAS 39 - Financial Instruments: Recognition and Measurement cover forbearance measures, even though IFRS does not use the term forbearance.  Paragraph 59(c) of IAS 39 states that objective  evidence of impairment includes circumstances when the lender, for economic or legal reasons related to the borrower’s financial difficulty, grants to the borrower a concession that the lender would not otherwise consider.  Consequently, the practice of extending forbearance measures constitutes an objective indicator that requires assessing whether impairment is needed.

Forbearance measures occur in situations in which the borrower is considered to be unable to meet the terms and conditions of the contract due to financial difficulties.  Based on these difficulties, the issuer decides to modify the terms and conditions of the contract to allow the borrower sufficient ability toservice the debt or refinance the contract, either totally or partially.

Assessment of impairment of assets subject to forbearance practices

As a forbearance measure is objective evidence of impairment, once such a measure has been identified, in accordance with paragraph 59(c) of IAS 39, an issuer shall evaluate whether this loss event has had an impact on the estimated future cash flows of the financial asset.  Accordingly, future estimated cash flows may need to be reduced or delayed, normally implying a decrease of their estimated present value and thus giving rise to an impairment loss which must be recognised.

In accordance with paragraph 63 of IAS 39, the issuer measures the amount of the impairment loss as the difference between the asset’s carrying amount and  the present value of estimated future cash flows (excluding future credit losses that have not been incurred), discounted at the original effective interest rate (i.e. the effective interest rate before modification of the terms of the contract).

Disclosures in the year-end IFRS financial statements

ESMA would like to stress the importance of issuers providing all relevant disclosures related to their exposures to assets that are subject to forbearance measures in order to comply with the requirements of IFRS 7 - Financial Instruments: Disclosures.  ESMA would also like to remind issuers that in order to achieve a fair presentation they are required, according to the principles in paragraphs 7 and 31 of IFRS 7, to disclose information that enables users of financial statements to evaluate the significance of financial instruments to their financial position and performance and the nature and extent of risks arising from financial instruments to which issuers are exposed.  Clear disclosures are particularly important for areas in which management judgement, as permitted by IFRSs, is applied.

ESMA together with national competent authorities will continue to monitor the level of transparency that issuers provide in their financial statements on forbearance related measures and their impact on impairment, and will consider whether further action is needed in order to ensure that the appropriate accounting treatment and level of transparency is provided by European issuers.

ESMA would expect that financial institutions include both qualitative and quantitative disclosures on forbearance in their 2012 annual audited IFRS financial statements.  ESMA is aware that financial institutions might not have collected sufficiently detailed quantitative information relating to forbearance to enable full disclosures along the lines requested in this statement to be made in the 2012 financial statements.  Nevertheless, ESMA expects that such quantitative disclosures are included in the financial statements to the maximum extent possible.  However, ESMA expects that these recommendations to be implemented and reflected in 2013’s annual financial statements, thereby enhancing the comparability of the IFRS financial statements of financial institutions in the European Union. 

ESMA will continue to monitor developments in the area of forbearance and co-operate with EBA and ESRB in addressing further this issue.

Full statement

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