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Classification and measurement of financial liabilities — Fair value option for financial liabilities

Date recorded:

The Board started the process of redeliberation of the proposal for classification and measurement of financial liabilities resulting from the ED Fair Value Option for Financial Liabilities.

Whether the effects of changes in own credit risk should be recognised in profit or loss

The Board discussed the alternative view expressed in the ED that would require changes in the credit risk of the liability not affect profit or loss unless such treatment would create a mismatch in profit or loss (in which case, the entire fair value change would be required o be presented in profit or loss).

The majority of the Board supported such approach. They argued that it would be conceptually correct answer as one of the conditions for application of the fair value option was to reduce the accounting mismatch (i.e. creation of the mismatch in profit or loss would go against the objective of fair value option in the first place).

On the other hand some Board members noted that such approach would be very complex and would lead to structuring opportunities. These Board members would prefer recognition of the entire change of own credit risk in other comprehensive income. They also argued that the mismatch is limited to a very few structures (e.g. Danish Mortgage Banks) but is not pervasive in other jurisdictions.

One Board member suggested that the recognition of the changes in the credit risk should be captured in profit or loss only to the extent of the mismatch and the remainder would be recognised in other comprehensive income. The Board disagreed as it felt that it would create the need for continuous reassessment of the effectiveness of the mismatch. Moreover, the staff noted that the inceptive for structuring in this case is limited due to creation of mismatches in profit or loss.

Finally, the Board agreed that the effects of the changes in liabilities' credit risk shall be presented in OCI unless that would create mismatch in profit or loss in which case, the entire fair value change would be required to be presented in profit or loss).

The Board also agreed that the entity would be required to perform a qualitative assessment to determine if it expects that the effects of changes in a liability's credit risk to be offset by a change in the fair value of an asset. If so, the entity would be required to present the effects of changes in the liability's credit risk in P&L. If not, the entity would be required to present those amounts in OCI. The entity would be required to make that determination at initial recognition and that determination would not be reassessed. One Board member challenged this decision as he noted that the mismatch might change over time. The Board disagreed as it felt that the irrevocable designation provides with a necessary rigour.

The Board also agreed that the entity would be required to disclose the basis for its determination. The Board also agreed that consistently with the guidance eon fair value option, there could be reasonable timing difference between the recognition of asset and liability.

How to determine the effects of changes in a liability's credit risk

The Board discussed the method ho to determine the effects of changes in a liability's credit risk. Based on the outreach activities, constituents in general supported the proposal in the ED to retain the guidance in IFRS 7 for determining the effects of changes in a liability's credit risk (i.e. default method in IFRS 7 attributes all changes in fair value, other than changes in benchmark interest rate, to changes of credit risk of the liability).

Nonetheless, some constituents noted that the default method might not be appropriate for some types of liabilities (e.g. liabilities including optionality). They also suggested providing additional application guidance for application of the default method.

The Boards agreed with the default method but also agreed to provide additional guidance that would identify instances when the default method would not be appropriate due to existence of optionality (e.g. volatility of interest rates etc.). The Board noted that explicit other features in addition to changes of benchmark interest rate should be excluded from the change of credit risk. The Board also reaffirmed that a different method could be used to determine the change of credit risk if it fulfils the objective of capturing the entire change related to credit risk.

The Board also discussed the FASB proposal that would distinguish between the changes in credit standing and changes in credit. The Board concluded that such method is conceptually different from the purpose of the IFRS and should not be used as a replacement of the default method in IFRS 7.

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