Discussion at the September 2008 IASB Meeting
The discussion of this topic ranged over three days of the September 2008 IASB meeting.
The staff introduced the session by highlighting the purpose of this session was a response to recommendations made by constituents, notably the Financial Stability Forum (FSF). The two main recommendations by the FSF were:
- Improve accounting and disclosure for off-balance sheet vehicles
- Strengthen standards to achieve better disclosures about valuations, methodologies and uncertainties associated with valuations
The FSF also recommended that the Board address these issues on an 'accelerated' basis.
The purpose of this session was to seek the Board's guidance on the basis by which the staff should develop proposals to amend IFRS 7 in relation to fair value measurement and liquidity risk. Also, the input from this session on off-balance sheet vehicles will be incorporated in the exposure draft on Consolidation expected later this year.
Liquidity risk
The staff presented two possible approaches to enhance disclosures for liquidity risk:
- Leave requirements in IFRS 7 unchanged for non-derivative financial liabilities (ie. liquidity analysis based on contractual maturities), but require disclosures based on expectations by the entity and how the entity manages risk for derivatives.
- Allow disclosure of maturity analysis based on expectation if this reflects the way the entity manages risk
The staff also recommended that, under either approach, the disclosures should apply only to liabilities that are within the scope of IAS 39 and that are settled in cash or another financial asset.
The Board had a lengthy discussion on the issue of allowing entities to disclose only information based on its expectations. Some Board members noted that information about contractual cash flows would also be useful. There seemed to be agreement that any approach should emphasise qualitative disclosures information on why an entity expects timing differences between the contractual cash flow and the expected cash flow and how such risks are managed. The Board suggested that staff consider whether some of the material in the Implementation Guidance of IFRS 7 should be made mandatory.
One Board member raised the issue of embedded derivatives, especially when they are embedded in non-financial host contracts. This Board member also asked whether the staff has considered the impact of increasing the disclosure requirement – something mainly aimed at financial institutions. The staff noted that it is of particular importance to agree the scope and then the appropriate treatment.
The Board agreed that the maturity analysis based on expectation should be accompanied by a contractual maturity analysis and that only instruments with the scope of IAS 39 should be included.
Fair value disclosure requirements
The staff introduced this part of the session by noting that recent market conditions led to requests by several parties to enhance disclosures about fair values. The staff noted that some of the recommendations made will be addressed in the long-term fair value measurement project, but that some short-term improvements in response to the credit crisis could be made: These are:
- Clarifying the fair value hierarchy in IFRS 7;
- Providing more direction on the form of the fair value disclosures, including references to a quantitative tabular format for disclosures; and
- Requiring a reconciliation from period to period for fair value measurements using significant unobservable inputs.
Clarifying the fair value hierarchy in IFRS 7
The staff noted that many entities have adopted an approach to classify fair values in a three-level hierarchy basically consistent with the hierarchy under US GAAP guidance in SFAS 157. These are:
- Fair values measured using quoted prices in active markets
- Fair values measured using valuation techniques for which inputs significant to the fair value measurement are based on observable market data
- Fair values measured using valuation techniques for which inputs significant to the fair value measurement are based on unobservable market data
The staff presented the Board with possible approaches to this:
- Option 1: introduce the SFAS 157 fair value hierarchy into both IFRS 7 and IAS 39 Financial Instruments: Recognition and Measurement.
- Option 2: introduce the SFAS 157 fair value hierarchy into IFRS 7 only.
- Option 3: use the existing fair value hierarchy in IAS 39, which represents what some entities are doing in practice to comply with both IAS 39 and IFRS 7's disclosure requirements.
- Option 4: make no changes to IFRS 7 with regard to a hierarchy, but specify which instruments (or types of instruments) require more disclosure.
- Option 5: make no changes to IFRS 7. Instead, entities could use material from the disclosure section of the expert advisory panel document, which summarises the disclosures users of financial statements would find helpful, in addition to those required in IFRS 7.
The Board agreed to option 3, which was the staff recommendation.
Tabular format for quantitative disclosures
The staff noted that the tabular disclosures required under US GAAP for fair values were well received by users. Staff recommended requiring such disclosures without a mandatory format. The Board agreed.
Requiring a reconciliation from period to period for fair value measurements using significant unobservable inputs
Staff proposed to require a reconciliation from period to period for level 3 fair values with narrative information on movement between levels. The Board agreed. It also agreed to require entities to provide an indication of the level within the hierarchy for unrecognised financial instruments, that is contracts outside the scope of IAS 39.
The staff noted that some had requested mandatory disclosures about fair values in interim reports. The staff highlighted that IAS 34 requires entities to provide information if significant changes occurred during the period. The Board agreed, but directed staff to put in a reminder on that provision.
Disclosure requirement for off-balance sheet entities
The next issue the staff presented were off-balance sheet involvements. One Board member noted that while most of the discussion focussed on financial institutions, the guidance being developed would be applicable to all entities, including corporates. Others suggested that this would lead to second-guessing and re-auditing judgements made by management and signed off by auditors. It was also noted that most of the disclosures would already be required by IAS 1 requirement for disclosure of significant judgements. There seemed to be a general sentiment that the proposal would end up in boilerplate disclosures that are not useful.
The Board was then presented with proposal for disclosure requirements to be incorporated in the new consolidation standard (that standard would replace IAS 27 and SIC-12 including disclosures). The following areas were covered:
- Consolidation decision made by management
- Application of consolidation policy
- Management of reputational risk
- Financial effect related to consolidation decision
- Nature of involvement and risks associated with involvement
- Other considerations
Consolidation decision made by management
The Board had a lengthy discussion on this topic, and while it agreed with the staff recommendation, the Board also asked the staff to consult with the Board advisors after the roundtables taking place later this week. There was general consensus that once an entity rebutted any presumptive indicator of control that is set out in a consolidation standard, that judgement must be disclosed.
The Board also had a lengthy discussion about reputational risk. The staff proposed that disclosures about reputational risk should be triggered only after there has been an event that damages an entity's reputation. At that point, there would also be disclosure of any expected impact on the future. Some Board members disagreed with that proposal and believed forward looking information would be better. Others were concerned about the term 'reputational risk' and asked the staff to rephrase it to what it actually meant.
Financial effect related to consolidation decision
The Board disagreed with the staff proposal to require disclosures of the effect on key financial indicators if an entity changes its judgement whether or not to consolidate an entity.
Nature of involvement and risks associated with involvement
The Board discussed at length the nature of 'involvement' as that term is used in the latest staff draft on consolidation. The discussion centred on possible disclosure of risks associated with involvement. Board members expressed concerns about the definition of 'significant involvement' and the amount of disclosures. There seemed to be no clear direction in the discussion (including items discussed that were omitted from the official observer notes), but it was clear that the Board seemed not convinced by the approach taken by the staff. In the end it was agreed to wait for the outcome of the roundtable on consolidation and then re-debate this issue along with other issues.
The staff working on improving liquidity risk disclosures asked the Board in this unheralded session to confirm their decision made on liquidity disclosures. The staff presented the Board with an agenda paper that was not publicly available and was basis for the discussions. The staff structured this brief session by looking at the following type of instruments:
- Stand-alone derivatives;
- Non-derivative financial liabilities; and
- Embedded derivatives in financial hosts.
Before addressing the types of instruments, the Board confirmed the scope of the liquidity analysis. The Board confirmed largely its decisions made on the first day of the September Board meeting (see our notes above).
The staff of the Consolidation project returned to continue its discussions with the Board on disclosures for off-balance sheet activities. The purpose was to discuss two issues:
- What instruments should be covered by significant involvement?
- How would disclosures look like?
The staff informed the Board that they might drop the term 'significant involvement' if it proved unhelpful. It was noted that most involvements with off balance sheet entities would be within the scope of IFRS 7 Financial Instruments: Disclosures, but staff proposed to require additional disclosures for the so-called off balance sheet entities. It was acknowledged that this term had to be refined. These additional disclosures would be quantitative and in a summarised tabular form to give users information on the assets held by those off balance sheet entities. One Board member questioned the availability of the data, but the staff responded if involvement is significant, reporting entities should know. The information provided should give users an indication on the degree of exposure to losses by the reporting entity.
Many Board members were again concerned about the notion 'significant involvement' and highlighted that it might cast too wide a net. It was noted that these issues do not arise under US GAAP as the disclosures are only required for a specified subset of entities. Board members highlighted that it was the involvement in excess of what is on the balance sheet that they were aiming at.
The staff then turned to disclosures for relationships outside the scope of IFRS 7. This would frequently occur when the reporting entity was the sponsor of the off balance sheet vehicle, but after setting it up had no further involvement.
However, as seen in the current credit crisis, entities would get involved with these entities again, mainly due to reputational concerns. There was concern about the availability of the information where the sponsor had no means to require the information from the off balance sheet entity. The Board discussed how to approach this. Board members questioned the frequency of helping such vehicles where there has been no obligation to do so and no other involvement. The staff was asked to analyse this.
The Board asked the staff to solicit views of constituents on the disclosures proposed by the staff and to bring the issue back to the Board.
October 2008: IASB ED on financial instruments disclosures
On 15 October 2008, the IASB issued an exposure draft of proposed amendments to IFRS 7 Financial Instruments: Disclosures. The proposals form part of the IASB's response to the credit crisis and follow recommendations of the Financial Stability Forum, which had the support of the Group of Seven (G-7) Finance Ministers. The proposals also reflect discussions by the IASB's Expert Advisory Panel on measuring and disclosing fair values of financial instruments when markets are no longer active. The ED, titled Improving Disclosures about Financial Instruments, may be downloaded without charge from the IASB's Website. The comment letter deadline is 15 December 2008 with a proposed effective date of 1 July 2009. Click for Press Release (PDF 93k).
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The exposure draft proposes the following changes to IFRS 7:
Fair value disclosures
- Introduction of a three level hierarchy when disclosing fair values (comparable to the US SFAS 157 hierarchy), as follows. Entities would be required to analyse and measure their financial instruments using this hierarchy and to disclose the amounts falling within each level of the hierarchy:
| Level | Fair value determination |
|---|
| 1 | Quoted prices in active markets for the same instrument (without modification or repackaging) |
| 2 | Quoted prices in active markets for similar assets or liabilities or other valuation techniques for which all significant inputs* are based on observable market data |
| 3 | Valuation techniques for which any significant input* is not based on observable market data |
*The ED defines 'significant input' as being significant in the context of the entire financial instruments. It also states that the assessment of significance of a particular input requires judgement.
- Disclosures required for each class of financial instruments carried at fair value:
- 1. The level in the fair value hierarchy into which the fair value measurements are categorised.
- 2. For any class of financial instruments that uses level 3 valuation techniques, a reconciliation from the beginning balances to the ending balances, to include separate disclosure of:
- a. total (realised and unrealised) gains or losses recognised in profit or loss for the period (and where they are presented within the statement of comprehensive income);
- b. total gains or losses recognised in other comprehensive income;
- c. purchases, sales, issues and settlements (net); and
- d. transfers into/out of level 3 (for example, transfers attributable to changes in the observability of market data).
- 3. The total amount of unrealised gains or losses included under 2(a) above for those instruments still held at the end of the reporting period, and a description of where those unrealised gains or losses are presented in the statement of comprehensive income.
- 4. For fair value measurements using valuation techniques for which any significant input is not based on observable market data (Level 3), if changing one or more of those inputs to reasonably possible alternative assumptions would change fair value significantly:
- a. that fact; and
- b. the effect of those changes for each class of financial instrument.
- 5. Any movements between the levels of the fair value hierarchy (in addition to those disclosed under 2(d) above).
- 6. The reasons for all movements between any levels of the hierarchy.
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- Reconciliations of balances for fair values measured without using observable market inputs
- Reconciliations of movements between the levels (including reasons)
Liquidity risk disclosures
- Clarification of scope of which instruments are to be included
- Disclosure of liquidity risk for derivative financial liabilities based on risk management of the entity
- Disclosure of expected remaining maturities of non-derivative financial liabilities if the entity manages risk in that way
- Enhance relationship between quantitative and qualitative disclosures of liquidity risk
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Deloitte has published a Newsletter (PDF 210k) with details of the Exposure Draft.
Discussion at the December 2008 IASB Meeting
This session aimed to seek Board's input on certain minor issues identified during the discussions on improving IFRS 7 in the light of the financial crisis. Constituents were concerned over some burdensome minimum disclosure requirements and that qualitative and quantitative disclosures are not integrated. The staff proposed a series of minor amendments. As a general amendment the staff proposed to change IFRS 7.32 by adding a statement that qualitative disclosures and quantitative disclosures should be integrated. The Board agreed.
The following list summarises the minor issues, the staff recommendation and the Board's decision:
| Paragraph in IFRS 7 | Description | Staff Recommendation | Board Decision |
|---|
| 36(a) | Maximum exposure to credit risk | Clarify that disclosure only applies to assets for which their maximum exposure to credit loss differs from their carrying amounts | Agreed |
| 36(d) | Financial assets with renegotiated terms | Remove | Agreed |
| 37(a) | Ageing analysis | Remain unchanged | Agreed |
| 37(b) | Individually impaired financial assets | Add a new disclosure requiring an entity to disclose an analysis of financial assets that are collectively assessed for impairment at the end of the reporting period | Disagreed |
| 37(c) | FV of collateral and other credit enhancements | Require disclosure of over- and under-collateralisation | Remove 37(c) but enhance IFRS 7.36 |
| 38 | Foreclosed collateral | Clarify that need only disclose amount held at reporting date | Agreed |
| 40(a) | Impact on profit or loss and equity | State in Implementation Guidance that encouraged to discuss effect of analysis on economic value
| Disagreed |
| 41 | Stress testing | No requirement needed | Agreed
| | 15 | Selling or repledging collateral | Remain unchanged | Agreed |
| 32 | Qualitative and quantitative disclosure | Insert sentence stating that qualitative should support quantitative disclosure | Agreed |
| 34(b) | Materiality | Remove reference to materiality | Agreed |
The staff recommended to the Board to process the agreed changes via the annual improvements process. The Board agreed.
December 2008: IASB proposes new debt investment disclosures
On 23 December 2008, the IASB issued an exposure draft proposing to amend IFRS 7 Financial Instruments: Disclosures to provide additional disclosures on all investments in debt instruments, other than those classified in the fair value through profit or loss category. The proposals would require an entity to state in tabular form the fair value, amortised cost, and amount at which the investments are actually carried in the financial statements. The amendments would also require an entity to also disclose the effect on profit or loss if all debt instruments had been accounted for at fair value or at amortised cost.
The IASB believes that the proposed disclosures will 'allow greater comparability between investments in debt instruments held with and by different entities, and so enhance investors' confidence in the financial markets'. The FASB is making similar disclosure proposals. The proposals are set out in an exposure draft Investments in Debt Instruments, on which comments are due by 15 January 2009. The exposure draft can be downloaded from the IASB's Website www.iasb.org until the end of the comment period. Click for Press Release (PDF 50k).
Discussion at the January 2009 IASB Meeting
Financial Instruments Disclosures
The staff introduced this session by reminding the Board members of the two main areas in ED Improving Disclosures about Financial Instruments (proposed amendments to IFRS 7):
- Clarifying disclosures about financial instruments
- Liquidity risk of financial instruments
Clarifying disclosures about financial instruments
The staff turned to the proposal of a tabular disclosure of fair values in accordance with a three level hierarchy (similar to the US requirements). It was noted that respondents linked this hierarchy to the measurement guidance in IAS 39 and were confused if they had interpreted the guidance in IAS 39 as containing a 2, 3, or 5 level hierarchy. Constituents were worried about how to map the IAS 39 fair value levels to the definition of levels under the proposals.
The staff therefore proposed not to go forward with the three level disclosure of fair value, but instead to provide additional information on level 3 disclosures, where some of the inputs in modelling fair value were unobservable. One staff member presented an alternative proposal. This staff member disagreed with the staff proposal and proposed to adopt the approach in the ED and make clear the definitions of the levels are exactly the same as under US GAAP. Also the final amendment was to make clear that there is no link between the IAS 39 measurement hierarchy and the fair value disclosure hierarchy under the proposed amendments.
While a majority of the Board members expressed sympathy for the alternative staff view, some were concerned that the timing for requiring such a fair value hierarchy disclosure would not be acceptable given that this issue would be addressed in a broader context in the fair value measurement project. One Board member noted that this amendment would not only affect financial institutions, but also corporates.
The Board voted in favour of the alternative staff proposal and against the staff recommendation.
The Board also agreed to:
- Replace the notion of 'total unrealised gains or losses' with 'total gains or losses'
- Require disclosure of the effect of changing one or more of the significant unobservable inputs used in the fair value measurement of level 3 financial instruments to another reasonably possible assumption
- Eliminate the requirement to stratify fair value in proposed paragraph 27C
Liquidity risk of financial instruments
The staff then turned to the proposed amendments to the liquidity disclosures. Staff noted that most respondents welcomed the proposed amendments to the liquidity risk disclosures under IFRS 7. In light of comment received, the staff proposed the following changes to the original proposals:
- Require disclosure of separate maturity analyses for derivative and non-derivative financial liabilities based on contractual maturities, but provide relief from disclosing in the maturity analysis contractual maturities for a subset of derivative financial liabilities
- Emphasise the existing requirement to provide summary data about each type of risk arising from financial instruments based on information provided internally to key management personnel of the entity, as required in IFRS 7.34(a). This also clarifies that derivative financial liabilities not included in the maturity analysis based on contractual maturities (under the proposed relief above) should be disclosed in a maturity analysis on the basis of the information provided internally to key management personnel.
- Clarify the following issues:
- the scope of the liquidity risk disclosures regarding derivatives that during their life can change between being financial assets or financial liabilities;
- how amounts are determined when the amount payable is not fixed; and
- how to consider master netting agreements.
- Retain the proposed treatments of
- hybrid contracts; and
- non-derivative trading liabilities.
- Clarify paragraph B11C so that it includes:
- derivative financial liabilities that are recognised in the statement of financial position;
- loan commitments that meet the definition of a derivative irrespective of whether they are recognised in the statement of financial position; and
- issued financial guarantee contracts.
- Strengthen the wording in paragraph B11E to ensure disclosure of a maturity analysis for financial assets used in managing liquidity risk, if that is important to users of financial statements in understanding the liquidity risk of the entity.
- Other drafting clarifications.
While Board members had some questions on the details of the proposed changes to the liquidity risk analysis, they agreed to all changes as proposed by the staff.
Transition
The staff proposed to bring forward the effective date of the amendments to annual periods beginning on or after 1 January 2009, but not to require comparatives. Some Board members were concerned over the backdating in the light of the requirements of IAS 34 for interim reports. Staff informed the Board that this is a broader issue and they plan to bring back a paper on it at the February Board meeting.
The Board agreed with the staff proposals.
IFRS 7 Amendment – Investments in Debt Instruments ED – Analysis of comments on the December 2008 Exposure Draft
The staff presented its comment letter analysis on the Exposure Draft Investments in Debt Instruments that would require additional disclosures for certain debt instruments. Staff said that the vast majority of respondents disagreed with the proposals, mainly for reasons of failed due process, doubts over usefulness of information, weakening the measurement bases chosen in the primary financial statements, and practical concerns.
Many Board members noted that such disclosures were requested by constituents and wondered why they now rejected them. The staff noted that the US FASB, which has exposed similar proposals, will be presented with a staff recommendation to drop the proposals (with the possible exception of requiring SFAS 157 disclosures for interims).
The Board agreed to abandon the proposals for the time being and to add the issues the ED aimed to address to the project on a comprehensive review of financial instruments accounting.
March 2009 Amendment to IFRS 7 Issued
On 5 March 2009, the IASB issued Improving Disclosures about Financial Instruments (Amendments to IFRS 7). The amendments require enhanced disclosures about fair value measurements and liquidity risk. Among other things, the new disclosures:
- clarify that the existing IFRS 7 fair value disclosures must be made separately for each class of financial instrument
- add disclosure of any change in the method for determining fair value and the reasons for the change
- establish a three-level hierarchy for making fair value measurements:
- 1. quoted prices (unadjusted) in active markets for identical assets or liabilities (Level 1);
- 2. inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly (ie as prices) or indirectly (ie derived from prices) (Level 2); and
- 3. inputs for the asset or liability that are not based on observable market data (unobservable inputs) (Level 3).
- add disclosure, for each fair value measurement in the statement of financial position, of which level in the hierarchy was used and any transfers between levels, with additional disclosures whenever level 3 is used including a measure of sensitivity to a change in input data
- clarify that the current maturity analysis for non-derivative financial instruments should include issued financial guarantee contracts
- add disclosure of a maturity analysis for derivative financial liabilities
Entities are required to apply the amendments for annual periods beginning on or after 1 January 2009, with earlier application permitted. However, an entity will not be required to provide comparative disclosures in the first year of application. Click for IASB Press Release (PDF 45k).
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