Tokyo, July 2010


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IFRS Academy, July 2010: Global Approach to Financial Reporting and Accounting for Financial Instruments

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Tokyo, July 2010

  1. 1. INTERNATIONAL IFRS ACADEMY<br /><ul><li>Set up in 1960, the EBF is the voice of the European banking sector (European Union & European Free Trade Association countries)
  2. 2. It represents the interests of some 5000 European banks: large and small, wholesale and retail, local and cross-border financial institutions
  3. 3. It is committed to supporting EU policies to promote the single market in financial services in general and in banking activities in particular
  4. 4. It advocates free and fair competition in the EU and world markets and supports the banks' efforts to increase their efficiency and competitiveness.</li></ul>Tokyo, 28-29 July 2010<br />A global approach to financial reporting and accounting for financial instruments<br />Roger KaiserEuropean Banking Federation<br />1<br />
  5. 5. GLOBAL APPROACH TO FINANCIAL REPORTINGNeed for Cross-border Transparency of Financial Statements<br /><ul><li>To enhance corporate performance’s comparability
  6. 6. To improve quality of financial reporting
  7. 7. To enhance investors’ protection
  8. 8. To increase the possibilities to raise capital
  9. 9. To create efficient, deep and liquid securities markets and enhance their international competitiveness
  10. 10. Need for adopting a single set of accounting standards for companies willing to raise capital …</li></ul>2<br />
  11. 11. GLOBAL APPROACH TO FINANCIAL REPORTINGKey Players in Accounting Standard-Setting<br />3<br />INTERNATIONAL<br />e.a. EU<br />NATIONAL<br />US<br />IAS / IFRS<br />Local GAAP<br />e.g. J-GAAP<br />US-GAAP<br />ACCOUNTING<br />STANDARDS<br />N’al Std-Setter<br />(NSS)<br />e.g. ASBJ<br />IASB<br />FASB<br />STANDARD-SETTERS<br />EC<br />JFSA<br />SEC<br />REGULATORS<br />
  12. 12. GLOBAL APPROACH TO FINANCIAL REPORTING US Convergence Strategy<br />4<br />INTERNATIONAL<br />e.a. EU<br />NATIONAL<br />US<br />IAS / IFRS<br />Local GAAP<br />e.g. J-GAAP<br />US-GAAP<br />ACCOUNTING<br />STANDARDS<br />N’al Std-Setter<br />(NSS)<br />e.g. ASBJ<br />IASB<br />FASB<br />STANDARD-SETTERS<br />EC<br />SEC<br />JFSA<br />REGULATORS<br />Convergence on Accounting Standards<br />
  13. 13. GLOBAL APPROACH TO FINANCIAL REPORTING US Mutual Recognition Strategy<br />5<br />INTERNATIONAL<br />e.a. EU<br />NATIONAL<br />US<br />IAS / IFRS<br />Local GAAP<br />e.g. J-GAAP<br />US-GAAP<br />ACCOUNTING<br />STANDARDS<br />N’al Std-Setter<br />(NSS)<br />e.g. ASBJ<br />IASB<br />FASB<br />STANDARD-SETTERS<br />EC<br />SEC<br />JFSA<br />REGULATORS<br />Mutual Recognition on Accounting Standards<br />
  14. 14. GLOBAL APPROACH TO FINANCIAL REPORTING<br />EU Strategy Towards a Single Set of Accounting Rules<br />Modernisation Directive<br />IAS Regulation<br />Fair Value Directive<br />EC Communication<br />“EU Financial reporting strategy: the way forward”<br />Lisbon European Council<br />4th and 7th AccountingDirectives<br />March 2000<br />June 2000<br />July 2002<br />2003<br />1978-1983<br />Sept. 2001<br />6<br />
  15. 15. GLOBAL APPROACH TO FINANCIAL REPORTING <br />EU Strategy : IAS Regulation & Modernisation Directive <br />Regulation (EC) No 1606/2002<br />unlisted companies<br />listed companies<br />individual accounts<br />consolidated accounts<br />individual accounts<br />consolidated accounts<br />IAS/IFRS permitted (optionality for member states)<br />IAS/IFRSrequired<br />Directive 2003/51/EC: Modernization & updating of accounting rules<br />7<br />
  16. 16. GLOBAL APPROACH TO FINANCIAL REPORTING <br />EU Strategy: Endorsement process for IFRS<br />SARG<br />EFRAG<br />technical level<br />ARC<br />political level<br />EUROPEAN COMMISSION<br />Regulations<br />EUROPEAN <br />PARLIAMENT<br />IASB<br />IFRIC<br />Endorsementprocedure<br />MEMBER STATES<br />transposition<br />MonitoringBoard<br />8<br />
  17. 17. 9<br />GLOBAL APPROACH TO FINANCIAL REPORTING Japan’s Strategy: Convergence Process<br />(Oct ‘02) Norwalk Agreement of IASB-FASB<br />EU’s Actions <br /> Japan’s Actions<br />Adoption of EU Directives  (‘03, ‘04)<br />(Jan ‘05)  ASBJ – IASB launched joint program for convergence<br />CESR Advice  (Jul ‘05)<br />(Jul ‘06)  BAC(*) report “Towards International Convergence of Accounting Standards”<br />(Oct ‘06) ASBJ published the project plan<br />Establishment of Japan-EU Monitoring  (Nov ‘06)<br />Meeting<br />(Aug ‘07)  Tokyo Agreement<br />(Dec ‘07)  ASBJ published the revised project plan based on the Tokyo Agreement<br />Decision on Equivalence of Japanese (Dec ‘08)<br />GAAP with IFRSs<br />(*) BAC (Business Accounting Council) is an advisory body on accounting matters to the JFSA<br />Tokyo Agreement  ASBJ agreed with IASB to accelerate convergence between J-GAAP and IFRSs<br /><ul><li>Eliminate the major differences or provide compatible accounting standards for the items which CESR advised in 2005, by 2008
  18. 18. Set a target date of 30 June 2011 for resolving other issues
  19. 19. Enhance cooperation to facilitate Japan’s greater contribution to the international standard-setting process</li></ul>Source: JFSA<br />
  20. 20. 10<br />GLOBAL APPROACH TO FINANCIAL REPORTING Japan’s Strategy: Roadmap for IFRS Application<br />Voluntary Application<br />Minimum 3 years<br />Scope: Certain listed companies whose financial or business activities are conducted internationally<br />Applied to: Consolidated Financial Statements<br />From: Fiscal year ending 31 March 2010<br />Decision on Mandatory Application<br />Possible Start of Mandatory Application<br /><ul><li>Around 2012: Decision regarding mandatory application of IFRSs
  21. 21. Preparation period: Minimum 3 years
  22. 22. 2015 or 2016: Beginning of mandatory application (if decided in 2012)</li></ul>Publication of Japan’s Roadmap (June 30, 2009)<br />Source: JFSA<br />
  23. 23. ACCOUNTING FOR FINANCIAL INSTRUMENTSKey accounting issues highlighted during the crisis<br /><ul><li>The G20 reaffirmed in June the need for a single set of high quality improved global accounting standards
  24. 24. Key accounting issues highlighted during the crisis:
  25. 25. Lack of transparency in financial statements and issues relating to the accounting for off-balance sheet structures </li></ul>-> addressed through disclosure requirements<br /><ul><li>Difficulties, uncertainties and pro-cyclicality associated with classification and measurement of financial instruments</li></ul> -> IFRS 9 Phase 1<br /><ul><li>Insufficient provisioning model (“too little, to late”)</li></ul> -> IFRS 9 Phase 2<br /><ul><li>Shortcomings of the hedge accounting rules -> IFRS 9 Phase 3</li></ul>11<br />
  26. 26. ACCOUNTING FOR FINANCIAL INSTRUMENTSCriticisms of Classification & Measurement in IAS 39<br /><ul><li>Complexity
  27. 27. Categories of financial instruments
  28. 28. Held-for-trading (HFT)
  29. 29. Held-to-maturity (HTM)
  30. 30. Loans and receivables (L&R)
  31. 31. Available for sale (AFS)
  32. 32. Mixed measurement
  33. 33. HFT  FV through P&L
  34. 34. HTM + LAR  amortized cost
  35. 35. AFS  FV through other comprehensive income (OCI)
  36. 36. Impairment rules
  37. 37. HTM and tainting rules</li></ul>12<br />
  38. 38. ACCOUNTING FOR FINANCIAL INSTRUMENTSClassification & Measurement of Assets in IFRS 9<br /><ul><li>Basically two categories and Mixed measurement maintained:
  39. 39. Amortised cost for assets held for contractual cash flows and managed on this basis
  40. 40. Fair value for everything else
  41. 41. Financial instrument characteristics and business model to shape boundary between categories</li></ul>-> Too restrictive definition of basic loan feature<br /><ul><li>Fair Value changes through P&L
  42. 42. Elimination of bifurcation of embedded derivatives in hybrid financial assets (on the asset side only)</li></ul>-> risk of measurement mismatches resulting in artificial volatility <br /><ul><li>No recycling of gains & losses equity instruments not held for trading</li></ul>13<br />
  43. 43. ACCOUNTING FOR FINANCIAL INSTRUMENTSLiabilities under IFRS 9<br /><ul><li>Liabilities scoped out of IFRS9-phase 1 because of difficulties with own credit risk
  44. 44. Exposure Draft on Fair Value Option for Financial Liabilities
  45. 45. No recognition of changes in credit spread of own debt instruments
  46. 46. Option to recognize the full change in fair value of financial liability if that reduces a measurement mismatch
  47. 47. EBF calls for non inclusion of subsequent changes in own credit through P&L
  48. 48. Frozen credit spread approach
  49. 49. Alternative solution: isolation of credit element of FV changes and posting through OCI</li></ul>14<br />
  50. 50. ACCOUNTING FOR FINANCIAL INSTRUMENTSCriticisms of Impairment in IAS 39<br /><ul><li>IFRS currently allow provisioning on actual losses incurred
  51. 51. IFRS currently do not allow provisioning on expected losses
  52. 52. The Basel II framework has been perceived as pro-cyclical and has led to calls for through-the-cycle provisioning starting at the point when loans are originated
  53. 53. EBF agrees on the “too little, to late” argument
  54. 54. EBF considers that new provisioning model under IFRS should be:
  55. 55. more forward-looking
  56. 56. consistent with risk management practices
  57. 57. based on information generated for regulatory purposes
  58. 58. cost efficient
  59. 59. aligned with the other components of the revised IAS 39</li></ul>15<br />
  60. 60. ACCOUNTING FOR FINANCIAL INSTRUMENTSCriticisms of Impairment in IFRS 9 (Expected Cash Flow Method) <br /><ul><li>Significant conceptual concerns of the Expected Cash Flow Model (ECFM)
  61. 61. Inclusion of expected credit losses in Effective Interest Rate (EIR)
  62. 62. Inconsistency with risk management practices and inapplicability of the model on open portfolios
  63. 63. Asymmetrical treatment of original estimations of expected losses and changes in expectations
  64. 64. Significant operational concerns of the ECFM
  65. 65. extremely complex proposal
  66. 66. implementation costs would significantly outweigh the perceived benefits
  67. 67.  Exacerbation of pro-cyclicality</li></ul> <br />16<br />
  68. 68. ACCOUNTING FOR FINANCIAL INSTRUMENTSAlternative Impairment Model proposed by EBF<br /><ul><li>The EBF has developed the Expected Loss over the Life of the Portfolio (ELLP) model
  69. 69. Determination of expected loss on a portfolio level
  70. 70. New model should not change the definition of amortized cost or the EIR calculation
  71. 71. It should separate the methodology for the recognition and presentation of interest income and credit losses
  72. 72. It should exclude credit losses from the application on the EIR
  73. 73. Methodology based on expected loss over the life of each portfolio
  74. 74. Treatment of impaired loans as in the current IAS 39
  75. 75. Impairment allowances built up to be used (not simply buffers)
  76. 76. Impairment allowances must be properly considered in the capital framework
  77. 77. ELLP model: a credible alternative to ECFM</li></ul>17<br />
  78. 78. ACCOUNTING FOR FINANCIAL INSTRUMENTSCriticisms of Hedge Accounting in IAS 39<br /><ul><li>The hedge accounting rules contained in IAS 39 are not in line with ALM practices used in many European countries
  79. 79. In particular, they do not enable banks to designate core/demand deposits as hedged items
  80. 80. Complex and restrictive effectiveness testing
  81. 81. EU hedge carve-out motivated by:
  82. 82. disproportionate and costly changes to ALM and accounting systems
  83. 83. resulting unwarranted volatility
  84. 84. Carve-out does not prohibit application:
  85. 85. individual companies may apply the ‘carved out’ provisions
  86. 86. EU Member State may make these provisions domestically mandatory</li></ul>18<br />
  87. 87. ACCOUNTING FOR FINANCIAL INSTRUMENTSHedge Accounting in IFRS 9<br /><ul><li>Crucial need for Hedge accounting principles to reflect consistently ALM practices and economic impact of hedging activities
  88. 88. Not yet a clear view of IASB proposals
  89. 89. Splitting approach
  90. 90. general hedging and financial items
  91. 91. portfolio hedge accounting and non-financial hedged items
  92. 92. Bifurcation by risks
  93. 93. Tentative “full” cash flow hedge accounting approach
  94. 94. A number of simplifications (documentation, etc) under examination</li></ul>19<br />
  95. 95. ACCOUNTING FOR FINANCIAL INSTRUMENTSUS-GAAP Update in a Nutshell<br /><ul><li>FASB has published a proposed Accounting Standards Update
  96. 96. Full Fair Value for all financial instruments with limited options for amortized cost
  97. 97. with FV changes reported in P&L or OCI
  98. 98. with OCI method differing from OCI under IFRS
  99. 99. Incurred loss + Allowances for credit losses to be applied to loans and debt securities held for long-term investment and to be estimated based on "expected losses“
  100. 100. Hedge accounting allowing hedging of specific risks
  101. 101. “Reasonably effective" hedging instrument
  102. 102. Qualitative analysis of effectiveness at inception</li></ul>20<br />
  103. 103. ACCOUNTING FOR FINANCIAL INSTRUMENTSClosing Remarks<br /><ul><li>Impairment and hedging likely to be delayed under IFRS</li></ul> ⇨ Is 2011 a realistic deadline for IASB?<br /><ul><li>Fragmented approach in development of IFRS 9 (3 phases)</li></ul> ⇨ EU endorsement process should commence only when<br /> all phases are complete<br /> ⇨ Need for appropriate lead-time for companies to start implementing<br /> systems<br /> ⇨ IASB should ensure as simple transition as possible<br /><ul><li>IASB and FASB announced revised convergence strategy and work plan</li></ul> ⇨ Convergence may not be sustainable in the short term<br /><ul><li>IASB and FASB are going in different directions and at different speeds</li></ul> ⇨ Need for equivalence and mutual recognition and<br /> acceptance by stock exchanges<br />21<br />