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Asset and liability offsetting

Date recorded:

The Boards continued discussions on the appropriateness of offsetting of financial assets and financial liabilities. Discussions were focused on the following three topics:

  • the appropriateness of netting in circumstances in which there is an unconditional right and intention to offset
  • whether an entity should offset a recognised asset and liability if it has an unconditional right to offset and intends to settle the asset and liability simultaneously
  • the appropriateness of offsetting when an entity has a conditional right to offset.

Primary model — Unconditional right and intention to offset

The staff believes that an unconditional right and intention to offset should form the primary basis for developing an offsetting model under the joint project. The staff noted this viewpoint is consistent with the Boards' joint Framework, is currently required under IFRSs, and is currently permitted under U.S. GAAP. Both Boards supported the staff's conclusions and recommendation; the IASB by a vote of 14-1 and the FASB by a unanimous vote.

One IASB member asked the staff what was meant by the term "primary" when describing the basis for a model, and whether that implied there were secondary or other bases for a model. After discussion, the staff clarified the unconditional right and intention to offset should be the starting point for a model under the project. A FASB member noted that the basis for a netting model was dependent upon the intent of the presentation (e.g., to show risk exposures or information about assets and liabilities). The Boards discussed the definition of intent, and some Board members expressed a belief that intent could be demonstrated through operational factors, such as an entity's historical practices, the execution of contracts that require net settlement, or other means. The Boards then discussed whether any operational concepts should be incorporated into a netting model. When called to a vote, both the IASB and FASB unanimously voted against such a measure, with some members citing the question was more akin to an auditing issue.

Next, the staff recommended to the Boards that offsetting should be required (consistent with current IFRS) if the offsetting criteria are met. The staff noted that making offsetting optional (i.e. the current practice under U.S. GAAP) would lead to diversity in practice; requiring offsetting would eliminate this diversity and provide more useful information to financial statement users.

Both Boards voted unanimously in favor of the staff's recommendation.

The staff also asked the Boards whether they agreed with defining the term unconditional as "a right of offset that is enforceable in all circumstances (including bankruptcy of a counterparty)". Both the IASB and FASB voted in unanimous support of the staff's recommendation.

Simultaneous settlement of a financial asset and liability

The staff asked the Boards whether an entity should offset a recognised financial asset and financial liability if the entity has an unconditional right to offset and intends to settle the asset and liability simultaneously.

The staff explained to the Boards that the term "simultaneously" is meant to be "at the same moment", when there is no exposure to liquidity risk or credit risk. One IASB member questioned whether a bright line would ultimately be created in practice through the interpretation of "simultaneously" and/or "at the same moment." Another IASB member asked the staff if it was aware of any current practice issues on the matter under IAS 32; the staff indicated that it was not aware of any significant issues. Another Board member asked the staff if the simultaneous settlement question represented an alternative or a refinement to the intent and ability (i.e. unconditional right) guidelines. The staff indicated offsetting in the event of a simultaneous settlement was meant to be a refinement, and stated its belief that this refinement would allow for more offsetting in practice.

The IASB voted 10 - 5 that an entity should offset a recognised asset and liability if the entity has an unconditional right of offset and intends to settle the asset and liability simultaneously. The FASB also voted in favor of this alternative by a vote of 3 — 2.

Offsetting with the conditional right to offset

Next, the Boards discussed whether offsetting would be appropriate given a conditional right of offset. The staff noted that a conditional right of offset focuses on an expected outcome in the event of a default or the termination of a contract, for example, the use of close-out netting in the event of a bankruptcy. For purposes of the discussion, the staff presented the Boards with three alternatives:

  • Alternative 1: Allow netting when an entity has a conditional right of offset (similar to current U.S. GAAP)
  • Alternative 2: Allow netting when an entity has a conditional right of offset and the contracts have the same risks or critical terms, or the instruments are the same
  • Alternative 3: Do not allow any netting if the entity does not have an unconditional right of offset (most similar to current IFRSs).

In stating a preference for Alternative 3, one IASB member noted that an entity should only offset if it has the intent and ability throughout the life of a contract. A FASB member agreed with the IASB member, indicating that close-out netting already represented an unconditional right, but the necessary event had not yet occurred to trigger the right. The FASB member also stated that an entity should not net contracts in a current period based on an event (i.e., a default, etc.) that has not yet occurred.

While indicating a preference for Alternative 2, an IASB member also emphasised the need for a final standard to include robust footnote disclosures that will provide users with useful information such as an entity's risk exposures, netting strategies, etc. Multiple board members agreed with this point, with one member noting footnote disclosures will be important regardless of which alternative the Boards agreed upon.

Multiple Board members reiterated that one of the underlying reasons for the offsetting project was to bring about convergence between IFRSs and U.S. GAAP. They noted that support for Alternative 3 appeared to achieve this goal. Two FASB members also stated their desire to achieve convergence; however, they noted that Alternative 3 would be a departure from current U.S. GAAP, and they questioned whether U.S. constituents had expressed any significant concerns about current U.S. GAAP requirements. One of these FASB members expressed a preference to retain the current U.S. GAAP model.

By a vote of 14 — 1, the IASB favored Alternative 3. The FASB voted in favor of Alternative 3 by a vote of 3 — 2.

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