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Fair Value Measurements – Credit Crisis: Proposed amendments to disclosure requirements

Date recorded:

The staff introduced the session by highlighting the purpose of this session was a response to recommendations made by constituents, notably the Financial Stability Forum (FSF). The two main recommendations by the FSF were:

  • Improve accounting and disclosure for off-balance sheet vehicles
  • Strengthen standards to achieve better disclosures about valuations, methodologies and uncertainties associated with valuations

The FSF also recommended that the Board address these issues on an 'accelerated' basis.

The purpose of this session was to seek the Board's guidance on the basis by which the staff should develop proposals to amend IFRS 7 in relation to fair value measurement and liquidity risk. Also, the input from this session on off-balance sheet vehicles will be incorporated in the exposure draft on Consolidation expected later this year.

Liquidity risk

The staff presented two possible approaches to enhance disclosures for liquidity risk:

  • Leave requirements in IFRS 7 unchanged for non-derivative financial liabilities (ie. liquidity analysis based on contractual maturities), but require disclosures based on expectations by the entity and how the entity manages risk for derivatives.
  • Allow disclosure of maturity analysis based on expectation if this reflects the way the entity manages risk

The staff also recommended that, under either approach, the disclosures should apply only to liabilities that are within the scope of IAS 39 and that are settled in cash or another financial asset.

The Board had a lengthy discussion on the issue of allowing entities to disclose only information based on its expectations. Some Board members noted that information about contractual cash flows would also be useful. There seemed to be agreement that any approach should emphasise qualitative disclosures information on why an entity expects timing differences between the contractual cash flow and the expected cash flow and how such risks are managed. The Board suggested that staff consider whether some of the material in the Implementation Guidance of IFRS 7 should be made mandatory.

One Board member raised the issue of embedded derivatives, especially when they are embedded in non-financial host contracts. This Board member also asked whether the staff has considered the impact of increasing the disclosure requirement - something mainly aimed at financial institutions. The staff noted that it is of particular importance to agree the scope and then the appropriate treatment.

The Board agreed that the maturity analysis based on expectation should be accompanied by a contractual maturity analysis and that only instruments with the scope of IAS 39 should be included.

Fair value disclosure requirements

The staff introduced this part of the session by noting that recent market conditions led to requests by several parties to enhance disclosures about fair values. The staff noted that some of the recommendations made will be addressed in the long-term fair value measurement project, but that some short-term improvements in response to the credit crisis could be made: These are:

  • Clarifying the fair value hierarchy in IFRS 7;
  • Providing more direction on the form of the fair value disclosures, including references to a quantitative tabular format for disclosures; and
  • Requiring a reconciliation from period to period for fair value measurements using significant unobservable inputs.

Clarifying the fair value hierarchy in IFRS 7

The staff noted that many entities have adopted an approach to classify fair values in a three-level hierarchy basically consistent with the hierarchy under US GAAP guidance in SFAS 157. These are:

  • Fair values measured using quoted prices in active markets
  • Fair values measured using valuation techniques for which inputs significant to the fair value measurement are based on observable market data
  • Fair values measured using valuation techniques for which inputs significant to the fair value measurement are based on unobservable market data

The staff presented the Board with possible approaches to this:

  • Option 1: introduce the SFAS 157 fair value hierarchy into both IFRS 7 and IAS 39 Financial Instruments: Recognition and Measurement.
  • Option 2: introduce the SFAS 157 fair value hierarchy into IFRS 7 only.
  • Option 3: use the existing fair value hierarchy in IAS 39, which represents what some entities are doing in practice to comply with both IAS 39 and IFRS 7's disclosure requirements.
  • Option 4: make no changes to IFRS 7 with regard to a hierarchy, but specify which instruments (or types of instruments) require more disclosure.
  • Option 5: make no changes to IFRS 7. Instead, entities could use material from the disclosure section of the expert advisory panel document, which summarises the disclosures users of financial statements would find helpful, in addition to those required in IFRS 7.

The Board agreed to option 3, which was the staff recommendation.

Tabular format for quantitative disclosures

The staff noted that the tabular disclosures required under US GAAP for fair values were well received by users. Staff recommended requiring such disclosures without a mandatory format. The Board agreed.

Requiring a reconciliation from period to period for fair value measurements using significant unobservable inputs

Staff proposed to require a reconciliation from period to period for level 3 fair values with narrative information on movement between levels. The Board agreed. It also agreed to require entities to provide an indication of the level within the hierarchy for unrecognised financial instruments, that is contracts outside the scope of IAS 39.

The staff noted that some had requested mandatory disclosures about fair values in interim reports. The staff highlighted that IAS 34 requires entities to provide information if significant changes occurred during the period. The Board agreed, but directed staff to put in a reminder on that provision.

Disclosure requirement for off-balance sheet entities

The next issue the staff presented were off-balance sheet involvements. One Board member noted that while most of the discussion focussed on financial institutions, the guidance being developed would be applicable to all entities, including corporates. Others suggested that this would lead to second-guessing and re-auditing judgements made by management and signed off by auditors. It was also noted that most of the disclosures would already be required by IAS 1 requirement for disclosure of significant judgements. There seemed to be a general sentiment that the proposal would end up in boilerplate disclosures that are not useful.

The Board was then presented with proposal for disclosure requirements to be incorporated in the new consolidation standard (that standard would replace IAS 27 and SIC-12 including disclosures). The following areas were covered:

  • Consolidation decision made by management
  • Application of consolidation policy
  • Management of reputational risk
  • Financial effect related to consolidation decision
  • Nature of involvement and risks associated with involvement
  • Other considerations

Consolidation decision made by management

The Board had a lengthy discussion on this topic, and while it agreed with the staff recommendation, the Board also asked the staff to consult with the Board advisors after the roundtables taking place later this week. There was general consensus that once an entity rebutted any presumptive indicator of control that is set out in a consolidation standard, that judgement must be disclosed.

The Board also had a lengthy discussion about reputational risk. The staff proposed that disclosures about reputational risk should be triggered only after there has been an event that damages an entity's reputation. At that point, there would also be disclosure of any expected impact on the future. Some Board members disagreed with that proposal and believed forward looking information would be better. Others were concerned about the term 'reputational risk' and asked the staff to rephrase it to what it actually meant.

Financial effect related to consolidation decision

The Board disagreed with the staff proposal to require disclosures of the effect on key financial indicators if an entity changes its judgement whether or not to consolidate an entity.

Nature of involvement and risks associated with involvement

The Board discussed at length the nature of 'involvement' as that term is used in the latest staff draft on consolidation. The discussion centred on possible disclosure of risks associated with involvement. Board members expressed concerns about the definition of 'significant involvement' and the amount of disclosures. There seemed to be no clear direction in the discussion (including items discussed that were omitted from the official observer notes), but it was clear that the Board seemed not convinced by the approach taken by the staff. In the end it was agreed to wait for the outcome of the roundtable on consolidation and then re-debate this issue along with other issues.

The staff working on improving liquidity risk disclosures asked the Board in this unheralded session to confirm their decision made on liquidity disclosures. The staff presented the Board with an agenda paper that was not publicly available and was basis for the discussions. The staff structured this brief session by looking at the following type of instruments:

  • Stand-alone derivatives;
  • Non-derivative financial liabilities; and
  • Embedded derivatives in financial hosts.
Before addressing the types of instruments, the Board confirmed the scope of the liquidity analysis. The Board confirmed largely its decisions made on the first day of the September Board meeting (see our notes above).

The staff of the Consolidation project returned to continue its discussions with the Board on disclosures for off-balance sheet activities. The purpose was to discuss two issues:

  • What instruments should be covered by significant involvement?
  • How would disclosures look like?

The staff informed the Board that they might drop the term 'significant involvement' if it proved unhelpful. It was noted that most involvements with off balance sheet entities would be within the scope of IFRS 7 Financial Instruments: Disclosures, but staff proposed to require additional disclosures for the so-called off balance sheet entities. It was acknowledged that this term had to be refined. These additional disclosures would be quantitative and in a summarised tabular form to give users information on the assets held by those off balance sheet entities. One Board member questioned the availability of the data, but the staff responded if involvement is significant, reporting entities should know. The information provided should give users an indication on the degree of exposure to losses by the reporting entity.

Many Board members were again concerned about the notion 'significant involvement' and highlighted that it might cast too wide a net. It was noted that these issues do not arise under US GAAP as the disclosures are only required for a specified subset of entities. Board members highlighted that it was the involvement in excess of what is on the balance sheet that they were aiming at.

The staff then turned to disclosures for relationships outside the scope of IFRS 7. This would frequently occur when the reporting entity was the sponsor of the off balance sheet vehicle, but after setting it up had no further involvement.

However, as seen in the current credit crisis, entities would get involved with these entities again, mainly due to reputational concerns. There was concern about the availability of the information where the sponsor had no means to require the information from the off balance sheet entity. The Board discussed how to approach this. Board members questioned the frequency of helping such vehicles where there has been no obligation to do so and no other involvement. The staff was asked to analyse this.

The Board asked the staff to solicit views of constituents on the disclosures proposed by the staff and to bring the issue back to the Board.

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