Background
This project examines how an entity's own credit risk or credit standing is reflected in measuring financial liabilities. It is part of the IASB's comprehensive review of accounting issues emerging from the global financial crisis.
Discussion at the May 2009 IASB Meeting
 Credit Risk
In December 2008, the IASB asked staff member Wayne Upton to prepare a discussion paper on the single issue of credit risk and how it is reflected in the measure of a financial asset or financial liability. Mr Upton presented his paper to the meeting and asked Board members to consider whether any substantive changes should be made to it before it is published.
Mr Upton explained that the discussion paper was not intended to be a complete history of the topic, but rather a discussion of the three principal arguments for and against including own credit risk in the measure of a liability. He suggested to the Board that the discussion paper not include any preliminary views, although he acknowledged that the IASB is on record as stating that credit standing is a component of fair value.
Mr Upton also noted that the Board had asked for the discussion paper to be prepared in order to isolate the issue of own credit risk and credit standing and allow constituents to focus on that issue alone when responding to the IASB, rather than have it as one of a number of issues in an invitation to comment; one that might not be as high a priority as another issue in the same document.
Board members generally agreed with the approach and in particular that it should not contain any preliminary views. Board members had specific suggestions for modifications and improvements, which Mr Upton asked for some leeway to incorporate, noting his desire to have a short, easily digested document.
The Board did ask that worked examples illustrating the financial statement effects of the various approaches discussed. Board members noted that how the effects of changes in credit standing were presented in the financial statement were critical to the topic.
In addition, Board members noted that the discussion paper should be candid about what would happen if credit standing was excluded from measurement: there were significant implications for derivatives and cash flow hedges in particular.
The Board agreed to issue the discussion paper on a 'negative clearance' basis. No comment period was recommended. The discussion paper is likely to be published in June or July 2009.
June 2009: IASB discussion paper on 'own credit risk'
On 18 June 2009, the IASB published a discussion paper on the role of an entity's own credit risk in liability measurement. The discussion paper (DP/2009/2 Credit Risk in Liability Measurement) is accompanied by a staff paper that describes the most common arguments for and against including credit risk in measuring liabilities. The paper notes that IFRSs require profit or loss resulting from changes in 'own credit' to be booked when debt is fair valued, but that some see the outcome as counter-intuitive (gains recognised in the face of deteriorating credit). The discussion paper addresses this concern and examines bases for liability measurement other than fair value. The issue of 'own credit risk' has relevance to a range of IASB projects, in particular in the accounting for financial instruments, insurance, fair value measurement, and provisions, contingent liabilities and contingent assets. Comments are due by 1 September 2009. Click for IASB Press Release (PDF 98k).
Deloitte's IFRS Global Office has published an IAS Plus Update Newsletter – IASB Seeks Views on the Role of Credit Risk in Liability Measurement (PDF 72k) explaining the discussion paper.
Discussion at the September 2009 IASB Meeting
Comment letter analysis
The Board discussed the feedback from constituents on this session. No decisions were made.
The main message from the constituents can be summarised as follows: Own credit risk should be included on initial recognition of financial liabilities, initial recognition of non-financial liabilities measured at fair value, and in cases when initial consideration is exchanged. On the other hand, on subsequent measurement own credit risk shall be included only when financial or non-financial liabilities are measured at fair value. The responses did not elaborate on the difference between measurement of credit risk via rating or credit spread.
Some constituents proposed a new measurement category, fair value adjusted for changes in own credit risk. Constituents observed that for a Level 1 instrument (observable market price), own credit risk was hard to extract, and for other instruments, it might be very difficult to be estimated.
The staff noted to the Board that many constituents stressed interaction between this analysis and conclusions reached (or to be considered) in the Classification and Measurement phase of the Financial Instruments project.
The staff will provide further analysis to the Board on October Board meeting, when the Board would be asked for direction on this project.
Discussion at the October 2009 IASB Meeting
The Board continued its discussion of the comments received on its Discussion Paper Credit Risk in Liability Measurement and deliberated the next steps for this work stream.
There was broad consensus that on initial measurement credit risk should be included in the measurement of at least some liabilities.
Some of the respondents thought that credit risk should always be included, although those respondents would limit this answer to financial liabilities. A few respondents thought that credit risk should always be included in initial measurement of all liabilities. Very few respondents would never include credit risk in initial measurement.
On subsequent measurement, views were more divided. Many agreed that credit risk should be included sometimes, although a significant number thought that it should not be included. Only a few would include credit risk at all times – again, this was in the context of financial liabilities.
The Chairman sought to clarify the preference among respondents for the 'frozen credit spread' approach and whether this was consistent with fair value. Staff acknowledged that using a frozen spread approach could lead to a measurement that diverged from fair value. (If the risk-free rate declined and the margin on AA-rated debt increased, an entity would mark away from market/fair value.) The staff noted that the DP had attempted to observe that there were two bits to the frozen spread approach, but only a few respondents had commented on it (see, for example, HSBC's comments).
Many Board members were frustrated by the lack of response from constituents about how to measure the frozen credit spread – often spending more time commenting on what should or should not be measured at an amount reflecting credit risk.
Staff noted also that constituents' apparent support for a frozen credit spread approach was probably a product of profound dislike for the other possible approaches discussed in the DP. However, the approach needed to be put in the context of a particular standard to obtain better and harder data.
The Board moved to discuss staff recommendations for this work stream and the information gained from the DP and made the following decisions:
- The Board agreed that no further work on credit risk in liability measurement as a separate work-stream should be undertaken.
- The Board would be required to make decisions about liability measurement in individual standards-level projects.
- The Board agreed that the definition of 'fair value' should not be modified as a result of the DP. Decisions about how 'fair value' is applied belong properly in the Fair Value Measurement project and individual standards-level projects.
It is possible that, in any particular project, the Board might agree a measurement attribute as fair value 'as modified' (for example, fair value 'less costs of disposal'). Board members noted that this decision might be troublesome to constituents.
Should the notion that credit risk is inherent in the measurement of fair value be included in the IASB's Framework?
The staff noted that most applications of fair value to liabilities occur in the context of financial instruments. Several other IFRSs require current information to be incorporated in liability measurement (but not fair value as defined), including IAS 19 and IAS 37. Board members seemed to think the idea of embedding the notion credit risk being included in liability measurement in the Framework as a general concept was the right approach. How the concept was applied would be left to the Fair Value Measurement standard and other IFRSs.
The Board discussed non-performance risk, and its interaction with credit risk. Non-performance risk was a notion introduced by the FASB in Statement of Financial Reporting Concepts No. 7 (CON 7) and was an attempt by the FASB to address the physical as well as the financial incapacity to discharge an obligation. The Board discussed this issue for some time, essentially coming to a common understanding of what CON 7 was saying and how its concepts might be applied in an IASB context.
The Board agreed with the staff's assessment that the interaction of non-performance risk and credit risk could not be addressed satisfactorily at a concepts level, but needs to be addressed explicitly in each project when a liability measure is at issue. (This approach would be applied to all future projects, not existing IFRSs or projects in an advanced state of deliberations.)
| 
Print
