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IAS 19 — Discount rate

Date recorded:

In October 2012, the Committee received a request for guidance on the determination of the rate used to discount post-employment obligations. The main concerns of the submitter were that:

  1. according to paragraph 83 of IAS 19 the discount rate should be determined by reference to market yields at the end of the reporting period on high quality corporate bonds (HQCB);
  2. IAS 19 did not specify which corporate bonds qualify to be HQCB;
  3. listed corporate bonds were considered to be HQCB if they received one of the two highest ratings given by an internationally recognised rating agency (e.g. ‘AAA’ and ‘AA’ from Standard and Poor’s); and
  4. because of the financial crisis, the number of corporate bonds rated ‘AAA’ or ‘AA’ (AA-Bonds) had decreased significantly and were traded less frequently. It was therefore considered that single trades could influence market yield more significantly than in the past and eventually distort the observable market rate, which would in turn distort the discount rate.

In particular, the submitter asked the Committee whether corporate bonds with an internationally recognised rating lower than “AA” could be considered to be high quality corporate bonds (HQCB). The submitter noted that two views existed in practice:

  1. only AA bonds were considered HQCB
  2. corporate bonds with a rating lower than AA could be considered HQCB

In its January 2013 meeting, the Committee:

  • requested the staff to consult with the IASB:
  1. i.            to confirm that the underlying principle for the determination of the discount rate is set out in paragraph 84 of IAS 19 (2011), and is described as “the discount rate reflects the time value of money but not the actuarial or investment risk”;
  2. ii.            to provide clarity about this sentence in paragraph 84;
  3. iii.            to ask whether this sentence in paragraph 84 means that the objective for the discount rate for post-employment benefit obligations should be a risk-free rate; and
  4. iv.            to confirm that IAS 19 should be amended to clarify that when government bonds are used to establish the discount rate in the absence of HQCBs, those government bonds used must themselves be high quality.

In the February 2013 IASB meeting, the staff asked the Board members if they agreed:

  1. that the objective for the determination of the discount rate is paragraph 84 of IAS 19, i.e. “the discount rate reflects the time value of money but not the actuarial or investment risk.  The Staff also asked the Board members whether they agreed that the discount rate does not reflect the entity-specific credit risk borne by the entity's creditors, nor does it reflect the risk that future experience may differ from actuarial assumptions.”
  2. that the Interpretations Committee should clarify the sentence “the discount rate reflects the time value of money but not the actuarial or investment risk” and that this sentence does not mean that the discount rate for post-employment benefit obligations should be a risk-free rate
  3. that the discount rate should reflect the credit risk of HQCB and that a reasonable interpretation of HQCB could be corporate bonds with minimal or very low credit risk
  4. that the Interpretations Committee should propose amendments to IAS 19 to specify that when government bonds are used to determine the discount rate those bonds should be of high quality.

The majority of IASB members agreed.

At the March 2013 Interpretations Committee meeting the Staff noted that their proposed next steps were:

  • to bring to the May 2013 Interpretation Committee meeting a draft amendment to IAS 19 (narrow scope amendment) that will reflect the tentative decisions of the IASB in the February 2013 meeting
  • to clarify in the draft amendment that in determining the discount rate an entity shall include corporate bonds with minimal or very low credit risk issued in other countries, provided that these bonds are issued in the currency in which the benefits are to be paid.

The Staff noted that in their view, in this narrow scope amendment guidance should be provided for determining the discount rate when there is no deep market for corporate bonds with minimal or very low credit risk and when government bonds are not “high quality”.  The Staff noted that their preliminary view was that in this situation, an entity should use the government bonds and adjust the yield of these bonds removing the market premium for the additional credit risk.

The Staff asked the Interpretation Committee members whether they had any comments on the proposed next steps.

One Committee member questioned what “minimal or low credit risk” means.  She asked whether it meant AA rated bonds or above and that guidance needed to be developed to enable this concept to be applied in practice.  She noted that maintaining that just HQCB with “minimal or low credit risk” are used in the determination of the discount rate without further explanation would create application issues and questions.  She also asked what one would do where there is no HQCB and noted that although the Staff were proposing to create a synthetic yield curve this notion had always been rejected.  She mentioned that she envisaged practical difficulties in removing the market premium for additional credit risk.  Another Committee member agreed that with the confusion created by the terms “minimal or low credit risk”.  He also noted that this also implied a choice – to use HQCB with minimal or low credit risk in determining the discount rate.  He agreed that there is still the question whether to use AA/AAA corporate bonds etc.

This view was not shared by a couple of Committee members who noted that they did not feel that minimal or low credit risk would create confusion as the term was taken from a known credit rating agency and was a term used in practice.

Another Committee member was also concerned with the creation of a synthetic curve for government bonds that were considered “junk bonds” and how this would actually be created.  This view was shared by another Committee member who noted that a number of companies in countries such as Asia and South America do use government bonds when there is not a deep market for HQCB.  He noted that for them to attempt to create a synthetic yield would represent a huge task for them.  This member questioned whether a different approach could be explored with actuaries as in order to determine what the discount rate for employee benefits should really represent.  This proposal for a different approach was also shared by another Committee member.

One Committee member shared the view that the focus should be on the principle in IAS 19 for determination of the discount rate rather than trying to set a rate as AAA/AA and trying to create a synthetic rate.

The Chair was receptive to the proposal of involving actuaries/capital markets and for the Staff to gain further insights before discussing the matter further.  The Chair also noted that if the Staff conclude that more fundamental work on the discount rate is required then the work should be moved to the broad research project on discount rates.

One Committee member proposed that if there were no high quality government bonds or there was no deep market for corporate bonds with minimal or low credit risk then one should go and search for the highest available high quality government or corporate bond.  She gave the example that if there were “junk” government bonds but higher quality corporate bonds then one should use these higher quality corporate bonds rather than constructing a synthetic yield on government bonds.  This view was shared by another Committee member who also noted that if the Staff involved actuaries then it would take a long time to come to a solution and the issue was a very real one now.

The Chair brought the discussion to a close and noted that there were three views being formed:

  1. to follow a principle of selecting the highest available bond available where there are no high quality government bonds and there is not a deep market for corporate bonds with minimal or low credit risk (shared by some Committee members);
  2. to concede that this issue cannot be addressed except in the context of the broader Board project on discount rate;
  3. the Staff should consider this issue further and come back to the Interpretations Committee with further considerations at the next meeting.

The Chair proposed option 3 to the Committee members.  No votes was held on this topic.

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