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Amendments to IAS 39: The Fair Value Option

Date recorded:

The Board considered a proposal for how to proceed with this project, following on from consideration of 116 comment letters received, most of which were in disagreement with the proposals contained in the exposure draft issued in April 2004. The overwhelming majority of respondents had expressed a preference for retaining the full fair value option as currently contained in IAS 39. However, a number of regulators do not support this, and reverting to the full fair value option would not solve the regulators' concerns that that Board had tried to resolve through the exposure draft. The Board noted, however, that not all regulators in Europe disagree with the full fair value option.

Some of the regulators had proposed an alternative approach under which items could be measured at fair value when they are part of a group of financial assets and financial liabilities managed together on a fair value basis in accordance with a documented risk management policy. The Board agreed that it was not able to make such a suggestion operational, for a number of reasons. These include defining when a group of assets and liabilities is considered to be 'managed together' and providing guidance on the interpretation of the phrase 'documented risk management policy'. Furthermore, such a proposal would not work for activities where it is not possible for both the assets and liabilities to be measured on a fair value basis, for example the insurance industry. It was also noted that this proposal would be more restrictive than the existing 'carve-out' version of IAS 39, because it would restrict the application of the fair value option to assets as well as liabilities.

It was noted that in South Africa, the full fair value option had been implemented early. While some difficulties have been experienced, in general it has been found that the full fair value option as is currently in IAS 39 is workable. It was noted that because IAS 39 requires designation at inception, designating something at fair value through profit and loss is not done spuriously because it has long term consequences. Therefore the reality has been that it is not possible to designate something at fair value through profit and loss to simply effect the recognition of a short term gain.

Staff noted that one of the major concerns that has been expressed is around the issue of 'admission' - that is, when is an entity eligible to adopt the fair value option. The Board considered a proposal that the entity is able to adopt the fair value option when the following criteria are met

  • Use of the fair value option corrects a measurement mismatch; or
  • The nature of the entity's activities is such that the use of the fair value options provides more useful information; or
  • The fair value option is simpler to apply than the accounting requirements that would otherwise apply, for example, accounting for embedded derivatives.

It was noted that this proposal had been published on the IASB's website and widely circulated for comment by 1 January 2005, as part of the IASB's extended due process. Comments received to date from regulators indicate that they are not supportive of this proposal.

Some respondents to the revised option had suggested the inclusion of more examples, with some even proposing that the examples form an exhaustive list of when the full fair value option is allowed. The Board disagreed, believing that there would always be one more example to be discovered, and that they could not justify an approach whereby the examples given were considered to be exhaustive. The Board agreed further examples should be considered for inclusion, and should be used to 'road-test' the revised criteria as proposed above. The Board agreed to proceed with endeavouring to operationalise the criteria described above, and to use the examples as assistance to do this rather than replacement criteria.

The Board noted that prima facie there appear to be internal inconsistencies between the objections raised by regulators in respect of the full fair value option and the proposals from the regulators to fix the problem. Concern was expressed that the Board appeared to be caught in the middle of what is ultimately a political debate, and that the perceived inconsistencies suggested to some Board members that they may not fully understand the concerns raised. It was noted that Board members have access to all documents sent to the Board highlighting concerns, but it appears the communication channels between regulators and the Board are such that the documents being received are not adequately illustrating to the Board the concerns. It was agreed that there was a need for round table discussions in which regulators who object to the option could discuss with other parties who support the option and try to come to an understanding of each others' views and how those parties together would wish the Board to proceed.

The exposure draft proposed that the fair value option could only be used where fair value is 'verifiable' - this was the most criticised aspect of the Exposure Draft. Respondents felt that it was an un-necessary extra test, the nature of responses indicated that the word 'verifiable' had not been consistently understood, and would therefore be unlikely to be consistently applied, and a 'verifiability' criteria might result in entity's going around in circles in respect of instruments that contain embedded derivatives. The Board noted that reliability underlies all IFRS, and there was no justification for an increase in the threshold in IAS 39. The Board believed the existing guidance on fair value (including that it should be free from bias) was sufficient to ensure an appropriate degree of reliability, but that paragraph 48A as exposed should be retained - this effectively brings the guidance from the application guidance into the standard.

The Board also noted that significant concerns had been expressed about 'own credit risk', and the fact that where an entity's own credit rating declines, application of the fair value option would result in a gain arising from the decrease in the fair value of its own liabilities. The Board acknowledged that this is of concern, but noted that no robust, readily implementable solution had been identified. The Board also noted that it seemed highly unlikely that an entity would designate a liability at fair value through profit and loss at inception simply to take advantage of its own expected future credit deterioration. Accordingly they agreed the existing disclosure requirement in IAS 32 in respect of this was a sufficient proxy of the effect of own credit risk, but was not sufficiently accurate to justify requiring it to be recognised in the accounts. Therefore the disclosure will continue to be required, but until a method of determining the effects of own credit risk can be determined that is capable of being made operational as part of an accounting standard, no recognition criteria will be introduced. The Board agreed a robust discussion of this issue and the reasons recognition requirements in respect of this are not addresses would be needed in the basis for conclusions.

A large proportion of constituents had objected to the inclusion of the reference to the role of the regulator in the exposure draft. The Board had agreed to include this reference at the request of certain regulators, believing it to be a gratuitous statement. However, a number of constituents were concerned that this sentence was bestowing on regulators a power to 'meddle' in the accounting policies used in general purpose financial statements by regulated entities. The Board noted that in some jurisdictions the regulator does have that power, but where the result of using that is non-compliance with IFRSs to meet regulatory requirements, the entity could not claim to be IFRS compliant.

A number of regulators had indicated that the inclusion of this sentence is considered a deal-breaker, and without it endorsement would not be possible. This concerned the Board greatly, as they did not understand how a sentence that they had understood as gratuitous could be a deal-breaker, and therefore believed that regulators are placing greater importance on this sentence than the Board did. Accordingly the Board agreed they need to obtain a greater understanding from both regulators and constituents as to what was meant by this sentence before proceeding. It was proposed that this should be raised in the roundtable discussions. Subject to anything that might be uncovered by obtaining this greater understanding, eight Board members agreed to retain the sentence as exposed with a more robust explanation in the exposure draft. The comments received on the revised criteria will be brought to the next Board meeting, and the Board would aim to hold roundtable discussions with invited constituents in February 2005.

ED 7 Financial Instruments: Disclosures

The Board considered responses to ED 7. It was noted that there were a large number of minor comments raised by different respondents, and that it would be most expedient for the Board to form a small group to identify which of these issues justify further Board discussion.

Respondents generally agreed that the Board should issue a standard containing the disclosure requirements in relation to financial instruments. Some Board members questioned whether it would be best to combine these requirements into IAS 32 to minimise the number of financial instruments related standards on issue. However, the Board agreed that as the liability/equity distinction is to be reconsidered in the future, it is easier to split the disclosures out into a separate standard at this juncture.

Board members considered whether the standard should try and separate the disclosure requirements into different categories - one for all IFRS preparers and one for financial institutions. However, the Board confirmed its earlier decision that it would not be possible to operationalise such a proposal, particular in trying to define the distinguishing features of the different types of entity. The Board agreed to keep a watching brief - the objective is that the disclosures made under ED 7 should fit the circumstances of the entity - if, for example, it appeared financial institutions were making insufficiently detailed disclosures to comply with the disclosure principles the requirement for a separate set of more detailed requirements will be reconsidered.

The Board confirmed its intention that the standard will require:

  • Disclosure of financial assets and financial liabilities by classification.
  • Net gains or net losses by classification.
  • Fee income and expense.

The Board agreed to reconsider at a later meeting the appropriateness of the proposed disclosures of information about any allowance account.

Respondents expressed significant concerns about the disclosure of the fair value of collateral and other credit enhancements. The range of concerns included that the information was difficult to obtain, may be misleading, and is potentially not worth having. The Board agreed that there was a need to disclose the relationship between collateral and the related liabilities for performing assets. A view was expressed that the requirement to disclose collateral was adequately dealt with by the impairment requirements where impairments had been recognised, and therefore the key disclosure issue rests with assets that are not performing but not yet impaired.

A large number of constituents objected to the proposed disclosure of a sensitivity analysis, citing concerns such as cost/benefit, comparability, and commercial sensitivity. It was noted that comparability should not be considered to mean that all the entities had completed their sensitivity analysis in exactly the same manner. Some constituents supported exemptions to this requirement for certain entities. The Board noted that it was inappropriate for SMEs to be excluded as this was a decision to be taken in the course of the SME process. The Board will further consider the appropriateness of the sensitivity analysis disclosure at a future meeting.

There was strong disagreement with the proposed disclosures relating to capital. Many constituents opposed the disclosure of external capital requirements, and an overwhelming number opposed the disclosure of internal capital requirements. Constituents felt that they may be penalised by the market if they disclosed breaches of internal capital requirements, and staff acknowledged a risk that as a response entities would set their requirements such that they would never be breached, and would therefore be meaningless. It was noted that the regulators involved in the development of the exposure draft had initially indicated their acceptance of these disclosures but some regulators had subsequently expressed doubts as to the appropriateness of the disclosures.

The Board confirmed the effective date and transitional provisions would be as exposed, with one change. An existing IFRS user that early adopts ED 7 will not be required to provide comparative information in respect of those disclosures not already required by IAS 32. It was noted that some of the new disclosures proposed by ED 7 - for example, the sensitivity analysis - are of limited value in historical information, and therefore granting an exemption did not detract greatly from information provided to users.

Many respondents did not agree that risk management type disclosures should be required in the financial report. Some noted that this seems unusual given that they are also in many jurisdictions required in the MD&A. The Board noted that they only have jurisdiction over the financial statements themselves, and entities could choose to incorporate information by cross reference rather than by duplication, providing that information would be subject to the audit requirements applying to the financial statements.

Many respondents supported the proposal that the disclosure requirements of IFRS 4 be changed for consistency with those proposed in the ED. However many insurance entities objected to this proposal, preferring instead to wait until Phase 2 of the insurance project is completed before making further comprehensive changes. The Board agreed that it would determine the requirements to be contained in the final standard and would then decide in conjunction with the insurance team how, if at all, these should be introduced into the requirements for accounting for insurance activities.

In general respondents felt that the implementation guidance was insufficient. Respondents requested more guidance, more examples and more illustrative disclosures. The Board discussed releasing the standard prior to the implementation guidance but agreed that this was not acceptable, as the implementation guidance is a good way of road testing the standard before release. The Board agreed to consider the extent of disclosures appropriate a t a future meeting after this has been considered by a smaller group and the advisory group.

A majority of respondents agreed that the additional disclosures proposed by the FASB's recent exposure draft should not be incorporated into the final standard. The Board agreed that inclusion of the additional requirements should not be required, and that as the requirements are in exposure draft format only, the Board should note that the FASB's thinking is still evolving. The Board agreed to advise the FASB that it would not include the additional requirements in the final standard and its reasons for choosing not to do so.

The Board noted that many respondents did not appear to have considered the issue of materiality in relation to disclosure - if a disclosure is not material it is not required. The Board agreed that the term 'minimum disclosure' had contributed to this confusion. The Board agreed to include in the basis for conclusions a statement regarding the impact of materiality considerations on the disclosures made and referring readers to IAS 1.

The Board will further debate the issues raised above that were not cleared at the meeting at a future meeting, as well as considering issues identified by the small group as needing Board consideration.

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