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Dynamic risk management

Date recorded:

Agenda Paper 4C: Feedback summary: users of financial statements

The Technical Director informed the Board that this session would provide an analysis of the comment letters that had been received on the Discussion Paper (DP) and that the Board was not required to make any decisions. He suggested looking at the users of financial statements first and then continuing with all respondents.

The Visiting Fellow introduced the agenda paper and notified the Board that there had been broad support for the project amongst users of financial statements.

The support was based on the view that existing accounting requirements did not represent dynamic risk management (DRM) adequately in IFRS financial statements. For banks, for example, a better representation of DRM activities would provide useful information.

Users had also supported the portfolio revaluation approach (PRA) as it enabled them to analyse a bank’s net interest income (NII). The PRA would split NII into a customer margin on the one hand and the results arising from the net open interest rate positions on the other hand. This would enable users to understand the composition, drivers and risks of the NII. There had also been support for decomposing the NII between before and after hedging.

Views had been mixed as to the question of how and where (P&L, OCI or notes) information on unhedged exposures on future NII should be presented. Users had generally supported behaviouralisation.

Concerns about the PRA included the lack of comparability if the application of the PRA should be optional and the subjectivity of behaviouralisation. Furthermore, concerns had been raised about the possibility of earnings management. Respondents to the DP had stressed that disclosures were necessary to alleviate those concerns.

One Board member found the support for information to understand the drivers behind the profitability of banks reassuring. A fellow Board member asked whether users would accept the higher volatility in the P&L if they got information on net open interest rate position. The Visiting Fellow replied that views were mixed but some would accept volatility as long as it reflected economic reality.

One Board member said that she understood the concerns of subjectivity of behaviouralisation. She said that if the estimates were based on the entity’s experience, it would be difficult to tell whether estimates had changed or whether actual numbers deviated from the estimate. Therefore, reliability of those estimates would be an issue. She also suggested segregating comments that had been made by insurers as in her view they were highly linked to the insurance project and could therefore complicate the DRM project.

A fellow Board member said that the concern about the departure from the Conceptual Framework was valid in his view and asked as to how this would be addressed. With regard to the accuracy of the revaluation of interest rate risk (which had also been raised by constituents) he asked whether the users whose responses were summarised in the agenda paper were specialised in banking. The Technical Director replied that the target for outreach activities were users who analyse banks’ financial statements, however there were other users present.

One Board member acknowledged the reliability concerns but said that behaviouralisation would have to be taken into account for the model to be aligned with risk management. Without behaviouralisation, core demand deposits would not be included in the model. She said that she was not concerned about reliability as this model would not be far from the expected credit losses model that had just been approved by the IASB. The Technical Director replied that the comment letters confirmed that the model required some form of behaviouralisation. The Visiting Fellow added that the real question was as to whether core demand deposits should be directly represented through behaviouralisation or indirectly using ‘proxy’ hedging. The Technical Director said that users preferred a direct representation.

One Board member asked the staff whether there had been discussions with banking regulators on the model. The Technical Director confirmed that and said that this would be covered in the next agenda paper. He said that regulators were not keen on the full scope of DRM but behaviouralisation would have to be considered. A Board member confirmed that. He said that in the comment letters the regulators had expressed disagreement with the volatility caused by the full scope.

Agenda Paper 4B: Comment letter analysis

The Visiting Fellow continued by explaining that the agenda paper only summarised the comments the IASB had received on the sections of the DP addressing the background and introduction to the PRA, the overview of DRM and PRA, the scope, the managed portfolio and the PRA through OCI approach. 

Respondents on the first three sections (background, overview, scope) found that the DP comprehensively analysed the limitations of accounting requirements if the risk management was dynamic. Many respondents therefore supported the necessity of the project but conceded that it would be challenging.

They preferred a scope focused on risk mitigation to a scope focused on DRM. One reason for this was that revaluing all DRM exposures was inconsistent with the objective of the project to address accounting mismatches between assets and liabilities. Another reason was that many banks managed current and future NII based on the accrual basis and that this would be consistent with IFRS 9. As a third reason, respondents said that for the purpose of conveying useful information about the ‘holistic’ picture of interest rate risk for future NII, disclosures would be better than recognition and measurement. Together with hedge accounting, a scope focused on risk mitigation led to faithful representation of DRM.

With regard to the conceptual and operational challenges of the PRA, several respondents made counter proposals. One was to amend the fair value hedge accounting guidance in IAS 39 on a portfolio hedge of interest rate risk. This way, departures from the Conceptual Framework would be limited. Another proposal was to explore approaches that could achieve the removal of accounting mismatches and operational feasibility at the same time. This included using cash flows of derivatives to calculate adjustments to offset fair value changes arising from derivative instruments or even apply cost accounting to derivatives.

Moreover, respondents pointed out the benefits and risks of the use of behaviouralisation. They agreed with including core demand deposits as they represented a significant part of banks’ DRM. Banks treated those as fixed interest rate funding.

Mixed views were expressed with regard to pipeline transactions and the equity model. Many disagreed with the PRA through OCI approach as it was conceptually flawed. Proponents said that it would reduce volatility.

One Board member said that many of the constituents believed the IASB were trying to solve the wrong issue as they believed that P&L volatility should be solved. Therefore, they disagreed with the dynamic scope. However, they did not offer concrete suggestions of how to develop the risk mitigation scope. In her view, the proposals basically stated that as long as there were risk mitigation effects, fully effective hedges could be assumed. She believed that by this they asked much of the Board.

A fellow Board member said that the project was very difficult as there was no common understanding of what the key performance indicators of financial institutions were. He said that analysts and preparers had diverging views with regard to the project.

One Board member asked whether the counter proposals made by respondents would be ignored. The Technical Director replied that although those were not fully developed models, they would still be considered.

No further comments were made.

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