ISAR 28 Application of Fair Value Measurement ...unctad.org/sections/wcmu/docs/ciiisar_28th_Santos2_en.pdfISAR 28 Application of Fair Value Measurement Requirements and Recognition

ISAR 28 Application of Fair Value Measurement Requirements and

Recognition and Measurement of Financial Instruments

Tuesday, 11 October 2011 Palais des Nations, Geneva

AFTERNOON SESSION

FINANCIAL INSNTRUMENTS:RECOGNITION AND MEASUREMENT

PRESENTED BY

Joao Santos

Financial Instruments Team International Accounting Standards Board

This material has been reproduced in the language and form as it was provided. The views expressed are those of the author and do not necessarily reflect the views of UNCTAD.

International Financial Reporting Standards

The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or IFRS Foundation

© IFRS Foundation. 30 Cannon Street | London EC4M 6XH | UK. www.ifrs.org

IASB UpdateIFRS 9

2011 October | IFRS 9 - Update

Agenda

• Classification and measurement– Financial assets

– Financial liabilities

• Mandatory effective date and transition• Hedge accounting

– General model

– Macro model

• Impairment

2



Classification and Measurement:Financial Assets


4

Overview of classification model: Financial assets only

Fair Value (No impairment)

Amortised cost(one impairment

method)Contractual cash flow characteristics

Business model testFVO for

accounting mismatch (option)

All other Instruments:• Equities• Derivatives• Some hybrid

contracts• …

Equities: OCI

presentation available

(alternative)

Reclassification required when business model changes


5

Amortised cost: Contractual cash flow characteristics

Contractual terms that give rise to solely payments of

Contractual cash flow characteristics

Interest =Consideration for•time value of money•credit risk

Principal Interest

Additional changes from exposure draft:

Structured debt—look through

Distressed debt

Non-recourse debt


6Equity investments: OCI alternative

Alternative presentation of fair value changes in other comprehensive income (OCI)Scope

investments in equity instruments not held for tradingFeatures

alternative available instrument by instrumentdividends recognised in P/Lno recycling, impairment or change in presentation


7

Summary of key changes to IAS 39:Financial assets

IAS 39 IFRS 9Classification Two measurement bases:

Amortised cost and Fair Value

Measurement

Many categories each with different measurement methods

Irrevocable option at initial recognition to present fair value changes of some equity investments in OCI

Impairment Different impairment rules depending on category and instrument type

Only debt instruments at amortised cost are tested for impairment

Tainting Tainting rules for held to maturity investments

No tainting rules

Reclassification Some reclassifications permitted/required

Reclassifications required if and only if business model changes

Embedded derivatives

Separation of embedded derivatives required in some cases

No bifurcation for financial assets, same classification approach as non-hybrid financial assets

FVO Available if specific criteria are met Available if eliminating or significantly reducing an accounting mismatch



Classification and Measurement: Financial liabilities


Overview of classification model:Financial liabilities

All financial liabilitiesAmortise

d cost

FVO for mismatch,

managed on FV basis and

hybridsExcept:

Held for tradingFair value through

P/L

Own credit in

OCI

• Hybrid financial liabilities are bifurcated

• No reclassification permitted

9


10‘Own credit’?• What is ‘own credit’?

– Fair value changes in liability arising from changes in the issuer’s credit quality

• How is it measured?– Often measured as change in margin over a benchmark interest

rate

• What is the concern?– Gain when credit quality deteriorates, loss when credit quality

improves– Reporting such gains and losses is not useful

– Board’s Request for Information on measurement of liabilities– ED on classification and measurement



Mandatory effective date and transition


IFRS 9: Mandatory effective date

• ED proposing to extend the mandatory effective date to 1 January 2015

• Comment period closes on 21 October 2011 • In November 2011, the Board will consider

comments received on the ED • The amendment, if any, would be issued by late

November

12



Hedge Accounting:General Model


14

Components of the hedge accounting model

Alternatives to hedge accounting

Presentation and Disclosure

Groups and net positions

Discontinuation and rebalancing

Effectiveness assessment

Hedging instruments

Hedged items

Objective

Hedge accounting(exposure draft)


15Objective

Risk managementobjective:

Seeks to link risk management and

financial reporting(top down)

Accounting objective:

Seeks to manage timing of recognition

of gains or losses(bottom up)


16Hedged items

Qualifying hedged item

Entire item Component

Risk component(separately identifiable and

reliably measurable)

Nominal component or selected contractual

CFs


17Hedged items: risk components

Benchmark (eg interest

rate orcommodity

price)


rate orcommodity

price)

Variable element

Fixed element


rate orcommodity

price)


rate orcommodity

price)

Variable element

Fixed element

IAS 39 ED


18Hedging instruments

Qualifying hedging instruments

Entire item Partial designation

FX risk component Percentage of nominal amount

• Intrinsic value• Spot element


19Costs of hedging

Time valueof options

Transaction related

hedged item

Time period related hedged

item

Costs of hedging

Forward element of forward contract


20Hedge effectivenessHedge

effectiveness

Hedge effectiveness test:1. Economic relationship2. Effect of credit risk3. Hedge ratio

Measuring and recognisinghedge ineffectiveness

Rebalancing Discontinuation


21

Total entity risk exposure(no specific disclosure

requirements)

Disclosures: scopeProposed scope for hedge accounting disclosures

Hedged exposure

(Exposure to risks being

hedged)

IFRS 7 Disclosure requirements

Significance of financial instruments for financial position and performance

Nature and extent of risks arising from financial instruments

Entity’s exposure attributable to the hedged risk


22Disclosures

Hedge accountingdisclosures

Risk management

strategy

Amount, timingand uncertainty

of future cash flows

Effects of hedge accounting on

the primaryfinancial

statements

Specific disclosures for

dynamic strategies and

credit risk hedging


23Alternatives to hedge accounting

Alternatives

‘Own use’ scope exception in IAS 39

Credit derivatives

Elective FVTPL•At initial recognition or subsequently

•At discontinuation: amortisationEligible for FVO in IFRS 9


24Transition• Prospective transition with limited exceptions

– Retrospective application– Required for time value of options

– Permitted for accounting for forward elements (if elected, applies to all such hedging relationships)

– Practical expedients– Allowed to consider the moment IAS 39 ceases to apply and the

moment from which the new model applies as one point in time

– For rebalancing, the starting point will be the hedge ratio used under IAS 39 (any gains or losses will be recognised in profit or loss)

– Hedging relationships that qualified under IAS 39 and qualify under the new model will be treated as continuing hedging relationships


General hedge accounting: timetable 25

• Exposure Draft on general hedge accounting published December 2010

• Redeliberations started in March 2011—completed in September 2011

• Staff draft of final general hedge accounting requirements available on website in Q4 2011 (for about 3 months)

• Effective date will be aligned with other phases of IFRS 9

Annual periods beginning on or after 1 January 2013/2015* with earlier application permitted

All existing IFRS 9 requirements must be adopted at the same time (or already have been adopted)



Hedge Accounting:Macro Model


Status of the Macro Hedge Accounting Project 27

Fact finding

Common themes

Implications for accounting model

Design of accounting model

Interest rate risk Other risks

Project status

Sept 2011


Insights from the project so far

Consumer Loans

Mortgage Loans

Commercial Loans

Demand DepositsTime Deposits

Other Liabilities• Margin (Bid-Offer Spread of Transfer Prices)• Repricing Risk / Yield Curve Risk / Basis Risk• Use of Risk Limits for Management• Volatility in net profit and loss due to:

• Differences in timing of cash flows• Basis differences• Amount differences (vintage)• Open positions

Treasury

• Margin:contractual market rate vs. internal transfer price

• Impairment Risk/Prepayment Risk/Market Rate Risk

• Volatility in profit or loss due to:Uncertainty regarding

impairment and prepayment

(model risk)• Margin for new business

dependent on market forces

• Margin:internal transfer price vs. contractual market rate

• Prepayment Risk / Market Risk

• Volatility in profit or loss due to:Uncertainty regarding prepayment (model risk)

• Margin for new transactions dependent on

market forces

Asset Liability Management (ALM)

• Capital Protection• Dividend targetsTrading Unit

Equity

• Management within predefined risk limits.• Trading Unit takes and manages the counterparty risk of the

entire derivative position.

Consumer Loans

Mortgage Loans

Commercial Loans

Demand DepositsTime Deposits

Other Liabilities

Treasury

Influence on risk limitand target cash flow profile

Internal Transactions(Derivatives)

Transfer (Benchmark) Prices - Component

28


EU IAS 39 ‘carve out’

IAS 39

Hedged items

Hedge effectiveness

Remainder...

29


Applicability to other industries 30



Impairment


Impairment: revised proposal Credit Quality Approach

(a) An expected deterioration in financial performance of the borrower that results in a change in credit risk from low/medium to medium/high, together with

(b) an increase in uncertainty about the ability to fully recover cash flows.

Bucket 1 Bucket 2 Bucket 3

Low to Medium Medium to High High to Very High

(a) A deterioration in financial performance of the borrower that results in a change in credit risk from medium/high to high/very high, together with

(b) expected non-recoverability of cash flows.

Cre

dit

Ris

k

• Internal credit categories need to be mapped to buckets• As loans are purchased or originated, they are classified in accordance with level of credit risk (eg

credit rating)• Loans migrate downward or upward depending on the change in credit quality/rating• Newly originated higher credit risk loans could be in Bucket 2 or 3.

Tran

sfer

bet

wee

n B

ucke

ts 1

-332


Impairment: revised proposal Allowance balance

* Can use loss rate basis for calculation

The boards have not yet decided on the measurement of Bucket 1 allowance.

Bucket 1 Bucket 2

Two possible approaches:•12 months’ worth of expected losses*•24 months’ worth of expected losses*

Full remaining lifetime expected losses

Bucket 3

Allowance balance equal to:

33


34

ImpairmentNext steps 34

• Boards continue to work towards converged solution • Discuss three bucket approach

– criteria for transferring between the buckets– whether Bucket 1 allowance should be 12 or 24 months of expected loss

• Further develop Credit Quality Approach (allocation to buckets based on credit quality)

• Address situations with significant day-one losses: – Business combinations– Purchased loans– Some business models

• Review full package of disclosures• Further outreach to address operationality of revised model

• Determine re-exposure or review draft Q4 2011


35Questions or comments?

Expressions of individual views by members of the IASB and its staff are encouraged. The views expressed in this presentation are those of the presenter. Official positions of the IASB on accounting matters are determined only after extensive due process and deliberation.

Documents

ISAR 28 Application of Fair Value Measurement ...unctad.org/sections/wcmu/docs/ciiisar_28th_Santos2_en.pdfISAR 28 Application of Fair Value Measurement Requirements and Recognition