28 March 2013

EBF response to the IASB's ED Classification and Measurement: Limited Amendments to IFRS 9

As EBF continues to support the business model as a basis for accounting, EBF considers IFRS 9 risks reducing the link between the actual business model and the accounting, undermining the ability of financial reporting to meaningfully portray the financial transactions in line with their economic substance.

The EBF appreciates the fact that the IASB has reconsidered IFRS 9 and attempted to improve the distinction between the cost category and fair value through profit or loss category. There are concerns however about how the SPPI (solely payment of principal and interest) clarification would be used in practice and over the instruments that will not pass the SPPI test despite consistency with the held to collect business model.

Since it is no longer realistic to envisage 2015 as a mandatory application date of IFRS 9, it would be preferable to introduce the changes to the own credit via amendments to IAS 39 rather than waiting for IFRS 9 to be implemented.

The EBF questions whether the results of IFRS 9 revision represent sufficient improvement over the classification approach in IAS 39 to make changing to a new approach worth the cost and effort.

Although the EBF understands the reintroduction of the fair value through other comprehensive income (FVOCI) category in the interest of convergence and to address insurance specific issues, the objectives of the IAS 39 revision would be better met by providing amendments to the IAS 39 ‘Available for Sale’ impairment requirements and introduce the proposals for own credit in IAS 39 as requested by the EBF previously.

The EBF would like to underline its support for accounting that appropriately reflects entities’ business models. A properly articulated business model should be helpful in communicating management’s understanding of the business to the market. However, this is more complex than just an accounting classification. Since the business model sets out how value is created and delivered to customers, for financial services companies the relationship between financial assets and liabilities is critical and looking at a portfolio of assets in isolation makes it difficult to create an accounting classification that can appropriately be described as a business model.

There is a tension between accounting being capable of reflecting the wide diversity of business approaches and setting accounting standards which conform to certain agreed concepts and result in consistent practice. The EBF considers that, with the limited amendments, IFRS 9 risks reducing the accounting classification to a matter of fact, based on defined criteria, which bear little relation to the business models as understood by management.

This disconnect between the actual business model and the accounting could undermine the quality of financial statements and the ability of financial reporting to explain the results. Specifically, where the requirements result in a fair value through other comprehensive income classification for portfolios which support amortised cost financial liabilities, the members of EBF do not consider that this appropriately reflects the business model. While it avoids accounting mismatches in net income, which the EBF strongly supports, it creates accounting mismatches in the balance sheet and movements in other comprehensive income (OCI) which are difficult to understand.

This leads to questioning whether these results are sufficient improvement over the classification approach in IAS 39 to make the change to a new approach worth the effort.

Last but not least, the EBF fully appreciates that the objectives of financial statements and regulatory objectives are not the same. However, in some cases the regulatory and accounting objectives are similar and given the wider economic impact of the accounting rules, the EBF would call for greater dialogue among standard setters, regulators and other policy makers. The EBF is particularly concerned about the relationship between the classification and measurement of financial instruments and the Basel III capital requirements, especially when differences in the accounting classifications will result in differences in required regulatory capital.

The EBF disagrees with the clarifications proposed to the HTC business model which are rules based and give undue emphasis to the frequency of sales. A certain level of sales is consistent with the amortised cost category, and the rules around these should not be so strict so as to preclude all financial assets including some current ‘loans and receivables’ qualifying for amortised cost measurement. As now worded the definition is very similar to the IAS 39 held-to-maturity category and it should be sufficiently broadened to address common practices around loans and receivables such as syndications and securitisations, allowing the loans that are retained to be maintained at amortised cost.

Financial reporting that reflects the business model results in presentation and disclosure which is more understandable. An artificial separation between the business model and the accounting, as has been experienced in the hedge accounting requirements, results in less meaningful information. This was one of the reasons for the changes in hedge accounting. It was hoped that IFRS 9 would result in a similar improvement for classification and measurement, but this now appears in doubt.

While the SPPI clarifications are helpful in some situations; the EBF considers the clarifications do not address all concerns. There remain concerns about how the clarification would be used in practice and over the instruments that will not pass the SPPI test despite consistency with the held to collect business model. Amortised cost would provide users with more useful information in circumstances when financial instrument features do not lead to leverage and do not impact fair value, for example when the feature is not considered to be an embedded derivative.

Since the EBF believes only a completed version of IFRS 9 should be allowed for implementation, EBF considers it is no longer realistic to envisage 2015 as a mandatory application date of IFRS 9. Taking into account the complexity and substantial changes expected to banks internal systems and processes in particular when implementing the new provisioning model, 3 years should be envisaged as implementation period once the standard is finalised.

While the possibility of early adoption of the finalised IFRS 9 should be evaluated against the resulting lack of comparability and the consequences, the modifications concerning the own credit requirements should be allowed for early application as soon as possible. The EBF takes the view that it would be preferable to introduce the changes to the own credit via amendments to IAS 39 rather than waiting for IFRS 9 to be implemented.

Comment letter

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