Credit Risk in Liability Measurement
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 was 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.)