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Financial Instruments: Classification and Measurement

Date recorded:

The Board met for a special meeting relating to the IAS 39 replacement project. Several Board members and FASB staff joined the meeting via video link or via phone. At this meeting the Board continued its re-deliberations on the Classification and Measurement phase and discussed issues related to hedge accounting.

Concentrations of credit risk

The staff introduced the session by summarising the proposals in the Classification and Measurement exposure draft (ED) and the feedback from constituents who disagreed with the proposals. The ED contained specific guidance for transactions where concentrations of credit risk were effected by tranches and proposed that only the most senior tranche might have basic loan features as that tranche received credit protection in any situation. Constituents argued that such guidance was an exception from a proposed classification model and could lead to structuring opportunities.

Responding to the feedback, the Board first clarified that it required separate assessment of the classification criteria by an issuer of contractually linked instruments that affect concentration of credit risk (as the notion of a 'waterfall structure' does not apply to the issuer when looking at its overall obligation).

The Board thoroughly discussed two proposals relating to the holder's accounting:

  • first, to require fair value for all instruments that reallocate credit risk (as it is not a basic loan feature), and
  • second to require a look-through approach to assess the underlying cash flow characteristics of the instrument and to assess the credit risk of the instrument relative to the underlying pool of instruments.

A majority of the Board supported the look-through approach as they believed that it ensured the same accounting treatment for the underlying assets as well as a proportionate interest in the same assets that received a credit protection. The Board agreed that an entity would have to look through until it identified the assets generating the cash flows (rather than passing them through). If such look-through was not practicable, the instrument would be measured at fair value.

Nonetheless, a significant minority of Board members disagreed with such a decision as they believed it would be contrary to the conceptual definition of basic loan feature (based on contractual cash flows). They also argued that economic substance of an investment in underlying assets and an investment in a securitisation vehicle based on those same assets is fundamentally different, and thus requiring the same accounting treatment for both is inappropriate.

In response to concerns of one Board member, the staff clarified that reassessment would not be required. However, if the pool of instruments could change so as to contain instruments that would be inconsistent with the structure having basic loan features over its entire life, any such structure would have to be measured at fair value.

One Board member expressed his preference for convergence with the FASB on accounting for securitisation vehicles. In response, the Chairman explained that to meet the deadline to publish the final IFRS in November, the staff needed the decision on this issue now, and discussions during the joint meeting would delay timetable of the project. Nonetheless, he noted that after the FASB model is finalised, convergence would be discussed, and thus subsequent changes to the IASB model developed for the IFRS would be possible.

Financial assets acquired at a discount that reflects incurred credit losses

The ED stated that a financial asset that was acquired at a discount that reflects incurred credit losses cannot be subsequently measured at amortised cost as it was not managed at a contractual cash flow basis and exhibited variability in actual cash flows that was not interest.

Constituents largely disagreed with such a decision as they believed that it represented an exception from the approach proposed and would pose operational challenges (for instance, to identify instruments with incurred credit losses when acquiring a portfolio).

The Board agreed with such arguments and reconsidered its earlier decision. Consequently, the Board decided that the fact that an asset was acquired at a discount that reflected incurred credit losses did not in itself disqualify it from being measured at amortised cost.

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