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Financial instruments – Asset and liability offsetting

Date recorded:

Alternatives for the offsetting model

The IASB and FASB discussed the overriding model for offsetting based on feedback received from the proposals in the exposure draft.

The Boards considered three possible alternatives for the offsetting model, including two variations of one of the three alternatives:

  • Alternative 1 would require offsetting financial assets and financial liabilities when a right of set-off exists that is exercisable in both the normal course of business and in bankruptcy, insolvency or default (this alternative is similar to the proposals in the exposure draft)
  • Alternative 2 would require offsetting financial assets and financial liabilities when a right of set-off is legally enforceable in the normal course of business (this alternative is similar to existing IAS 32 Financial Instruments: Presentation)
  • Alternative 3 would require offsetting financial assets and financial liabilities when a right of set-off exists that is only enforceable in bankruptcy, insolvency or default of one of the counterparties to certain derivative transactions executed under a master netting agreement (this alternative is similar to existing US GAAP). A variation of alternative 3 (3A) was also considered that only collateralised derivatives meeting the alternative 3 criteria would be allowed for offsetting.

 

The staff provided the Boards a summary of various transactions and how they would be presented under the various alternatives.

Both Boards agreed that neither gross nor net presentation in isolation provided financial statement users with sufficient information to understand the risks involved with financial instruments and that adequate disclosure was essential. However, most IASB members and some FASB members were of the feeling that Alternative 1 provided more transparency into the potential exposure than Alternative 3 provided.

Other FASB members felt that Alternative 3 was more appropriate because of the specific nature of derivatives (i.e. individual derivative instruments are already inherently measured on a net basis). They referenced that the existing US GAAP guidance permitting netting under master netting agreement contracts was not a source of concern during the financial crisis. They also stated their belief that if an entity were protected from credit risk of counterparty default, then that should be reflected in the balance sheet and that the argument that net presentation did not provided adequate information about future cash flow was equally relevant for gross presentation.

The IASB voted unanimously in favour of proceeding with an offsetting model under an unconditional right of offset approach (the set-off right exists in both the normal course of business and in bankruptcy, insolvency or default). The FASB voted (4-3) if favour of retaining an offsetting model under a conditional right of offset approach (set-off right exists that is only enforceable in bankruptcy, insolvency or default of one of the counterparties to certain derivative transactions executed under a master netting agreement).

The Boards then briefly discussed possible alternatives of how to resolve the different views. One IASB raised the question of linked presentation which was raised by some comment letter respondents. He noted that during participation in the offsetting roundtables held in Norwalk he had asked preparers, users and regulators if they could live with linked presentation as a form of compromise and each responded that they could. However, neither Board expressed much support for further exploring a linked presentation approach (only 2 IASB members were supportive of further exploration while no FASB members were supportive).

The IASB staff noted that if a resolution cannot be reached, the Boards may have to focus on a disclosure package which permits easy reconciliation between IFRS and US GAAP. The Boards had intended to discuss additional parts of the offsetting model the following day, but based on the Boards landing in different places with the overall approach, those additional discussions were cancelled.

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