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Notes from the IASB-FASB financial crisis roundtable in London

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17 Nov 2008

In response to the challenges caused by the current market conditions the IASB and the FASB have decided to hold a series of roundtables to gather views from constituents on the most urgent accounting issues and how to approach them.

The first roundtable was held in London on 14 November 2008. The second will be at the FASB's office in Norwalk, CT USA, on 25 November 2008. The final roundtable will be on 3 December 2008 at the offices of the Accounting Standards Board of Japan in Tokyo. Presented below are the preliminary and unofficial notes taken by Deloitte observers at the London roundtable.

Notes from the IASB-FASB Global Financial Crisis RoundtableLondon 14 November 2008

The London roundtable was divided into two 2.5 hour sessions. IASB Board Member John Smith chaired both sessions. The 44 participants were drawn from a wide range of constituents. It was noted that all next steps, in response to calls from constituents, will be considered jointly by IASB and FASB and following due process and, therefore, no decisions were taken at these roundtable meetings.

For the roundtable in London the following topics were discussed based on submissions from participants received:

  • Impairment of financial assets
  • Reclassification of financial instruments designated under the fair value option
  • Fair value measurement
  • Disclosures
  • Other issues

Impairment of financial assets

The chairman introduced the topic highlighting that the guidance for impairment both regarding triggers and measurement is different in IFRS and US GAAP.

Much of the discussion focussed on the different impairment models that exist in IFRS and US GAAP, particularly for impairment of debt instruments. Many participants believe there should be convergence. They commented most frequently on the differences between loan loss impairment for a debt instrument measured at amortised cost compared to one measured at fair value as an available-for-sale (AFS) investment. Recent market events had resulted in the latter being recognised at an amount significantly lower than if it has been measured under an amortised cost model due to the current market's assessment of credit and liquidity risk compared to an impairment that would have been recognised had the impairment been calculated using the original effective interest rate. Some participants put forward the idea that impairment of an AFS debt instrument should be recognised on the same basis as if the asset was measured at amortised cost. If that is done, differences due to liquidity risk or credit risk in excess of the incurred loss model would be recognised in other comprehensive income, rather than currently recognised in profit or loss. This led to a broader question about what impairment in income is meant to represent – loss of recoverable cash flows or loss in fair value.

Some participants raised a number of interpretative issues with the current model of impairing AFS debt instruments. Specifically, if an AFS debt instrument is impaired, are further declines in fair value considered as further impairments, or does this depend on whether further fair value declines are derived from movements in the risk-free rate as opposed to further declines in credit quality, or whether further declines in fair value are impairment losses only if there are further impairment triggers?

There was feedback from user groups as to whether impairment losses based on the incurred loss concept were useful even if the loss recognised in profit or loss is based on fair value. Some participants noted that fair value is a good predictor of real cash losses. It was also highlighted while there is a difference between impairment and fair value volatility, markets are usually better than individuals in predicting the performance of an instrument.

There was discussion of whether for equity securities an impairment loss should be allowed to be reversed through profit or loss – currently it is not. Some argued that as the trigger event is a significant or prolonged decline in fair value below cost, then should this trigger event no longer apply, the impairment should be reversed through profit or loss.

The Boards will consider whether amendments to the existing measurement guidance for impairment is needed, or alternatively whether further disclosure in the short term could be introduced to align the different impairment approaches. The chairman noted that the challenges resulting from the current guidance are rooted in the fact that there are different measurement classification categories within IFRS and US GAAP. Aligning the classification categories would address many of these issues.

Many of the participants agreed with this conclusion.

Reclassification of financial instruments designated under the fair value option

The roundtable then discussed the use of the fair value option and possible reclassifications out of this designation. Some participants sympathised with revising the conditions for invoking the fair value option to achieve convergence with US GAAP (that is, so the fair value option under IFRS is unrestricted) and widening the fair value option for certain arrangements over non-financial items not currently in IAS 39. Others proposed allowing reclassification out of the fair value option in case where conditions for invoking the fair value option are no longer met. Participants holding this view felt this was appropriate in the case of an accounting mismatch that existed when the fair value option was invoked which no longer applied, for example:

  • where financial assets were matching insurance liabilities and the continuation of the fair value option created more of an accounting mismatch, or
  • when the fair value option was used instead of fair value hedge accounting and the mismatch failed due to changes in fair value of the assets due to credit and prepayment risk, or
  • when the entity ceased to manage the financial instruments on a fair value basis due to difficulties in establishing fair value in the current markets.

Concern was raised that to allow an entity to reclassify in such circumstances would require further rules as what would be a permitted reclassification.

Fair value measurement

Regarding how to determine fair value, it was noted there was a recent submission to the IFRIC on how to include liquidity spreads in valuation when the market is no longer active. While many participants agreed that determining fair value is more challenging in inactive markets, it is not appropriate to normalise values or use liquidity spreads that do not reflect a current market participant's view of spreads. It was noted the view expressed in the IFRIC submission was not in accordance with IAS 39. Others referred to the work done by the IASB Experts Advisory Panel and that this guidance should indeed be authoritative (and not voluntary as it is at the moment).

The roundtable participants discussed the procyclical effects of fair value accounting. There seemed to be agreement that it is not the purpose of financial reporting to report 'regulatory numbers' that avoid overly positive or negative market movements. It was noted that within the European Union, ECOFIN has established a working group to analyse the roots of procyclicality and that Bob Herz (FASB chairman) and Sir David Tweedie (IASB chairman) would be on a Financial Stability Forum working party looking at procyclicality.

Disclosures

The chairman introduced this topic by presenting the various projects on the boards' agendas on the topic of disclosures. User groups were concerned that the IAS 39 amendment on reclassifications of financial assets issued in October 2008 only amended IFRS 7, which only deals with disclosure in annual accounts. User groups stated that there are widely different variations in the amount of disclosure in interim financial statements for entities that reclassified financial assets in Q3 and proposed that the additional disclosures included in IFRS 7 should be required in interims.

Other issues

The roundtable discussed the issue of accounting for synthetic Collateralised Debt Obligation (CDO) structures. Many speakers highlighted that there is a divergence between IFRS and US GAAP as to whether credit-related embedded derivatives require separation or not in the instance when the instrument is not fair valued through profit or loss. It was noted that both the IASB and FASB would consider this issue.

It was noted that clarification is needed on whether embedded derivatives need to be assessed if an entity reclassified an asset out of fair value through profit or loss as a result of the IAS 39 amendment issued last month. Some IASB Board members noted that the IAS 39 amendment was not intended not to require assessment of embedded derivatives. Participants noted that IAS 39/IFRIC 9 was not as clear as it could be in this respect. Staff from the IASB indicated that this would be addressed in the future, and the chairman stated that should the IASB issue a clarification it would most likely state that assessment of embedded derivatives would be required at the date of reclassification and it would be applied retrospectively.

One participant noted that the IASB and FASB projects on derecognition and consolidation did not seem to be aligned, and a request was made that they should be.

The chairman asked participants if there were other issues the boards should address. No participant raised other issues.

This summary is based on notes taken by observers at the Roundtable and should not be regarded as an official or final summary.

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