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FRC comment letter on the IASB’s Exposure Draft ED/2013/3 ‘Financial Instruments: Expected Credit Losses’

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25 Jun 2013

Following a consultation period on its draft comment letter, the Financial Reporting Council (FRC) has issued their final comment letter responding to the International Accounting Standard Board’s (IASBs) Exposure Draft ED/2013/3 ‘Financial Instruments: Expected Credit Losses’.

In the Exposure Draft (ED) the Board proposes a model according to which credit losses are no longer recognised if incurred; rather, entities would recognise expected credit losses on financial assets and on commitments to extend credit based upon current estimates of expected shortfalls in contractual cash flows as at the reporting date.

The final comment letter supports the majority of the proposals within the Exposure Draft (ED) and mirrors many of the messages contained within the draft comment letter.  However, following the consultation period, which ended on 14 June 2013, the FRC have included some additional comments in their final comment letter.  The final comment letter: 

  • Highlights that the FRC do not support the Financial Accounting Standards Board (FASB) alternative impairment model which requires entities to provide for full lifetime expected credit losses within the “foreseeable future” at the reporting date.  The FRC comment that they “do not believe that such a model is based on the underlying economics or reflects the risk management practices for financial institutions”.  The FRC then go onto say: “this model does not provide information to users on the credit deterioration of financial assets and the impact on the income statement”.  Where a uniform approach to expected credit losses is to be adopted, the FRC advise that the FASB and IASB converge to agree on the approach proposed by the IASB. 
  • Recommends that due to the ED allowing the use of a range of different discount rates, the IASB should determine an agreed approach to discounting using the results of its own field-testing exercise and that conducted by EFRAG and the European National Standard Setters. 
  • Recommends that the proposals include an example of how to calculate 12 month and lifetime expected credit losses on a bullet loan when no payments are due within 12 months. 
  • Recommends including clearer guidance on what is meant by “default” in the context of the proposed standard in the ED.  The FRC comment that this will “ensure that a consistent approach to moving assets along to stage 3 is adopted by all entities within the scope of the final standard”. 

Subsequent to the final comment letter being issued by the Financial Reporting Council, the European Financial Reporting Advisory Group (EFRAG) and European Securities and Markets Authority (ESMA) also issued their comment letters to the IASB.  Their comments are largely consistent with those of the FRC and support the belief that the IASB proposed approach is a pragmatic solution in the absence of a better model and overcome a number of operational challenges highlighted by constituents commenting on the 2009 ED.  However, despite the IASB’s attempts at reducing operational challenges, the EFRAG comment letter highlights that field testing had identified a number of operational difficulties to the proposed model.  In particular field test results highlighted that there would be high compliance costs in meeting the disclosure requirements and EFRAG would like to see the IASB revisit the proposals so that cost and benefit are balanced appropriately.  EFRAG also commented that “the current proposals do not allow entities to leverage existing risk management and regulatory practices and that not all necessary data are available”.  EFRAG would like the IASB to “reconsider how the model could be implemented in such a way that entities are able to leverage their existing practices and hence limit the costs and increase the reliability of their estimates”.  ESMA also commented that they do not fully support all of the proposed operational simplifications such as the introduction of an investment grade exception and commented that they would like the IASB to explicitly address forbearance practices as part of the final standard.     

EFRAG and ESMA make further suggestions which are contained in their respective comment letters.  Both the FRC and EFRAG strongly encourage the IASB to consider the field testing work carried out by EFRAG in finalising their proposals.  

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