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14 July 2010

CESR comments on the IASB’s exposure draft fair value option for financial liabilities


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CESR believes that IASB proposal would create a mismatch for some banks where assets and liabilities are closely matched due to changes in assets going to profit or loss and some changes in liabilities going to Other Comprehensive Income.


The ED is part of the IASB’s revision of IAS 39 – Financial Instruments: Recognition and Measurement, of which IFRS 9 – Financial Instruments: Classification and Measurement as published in November 2009, was the first part.
CESR supports the IASB’s tentative decision to maintain the current IAS 39 requirements regarding financial liabilities, except for specific amendments on the cost exception for equity derivatives and the treatment of credit risk for liabilities designated under the fair value option.
CESR welcomes the IASB’s initiative to maintain the bifurcation of embedded derivatives on the liabilities side, but is at the same time concerned that this might create inconsistencies with the assets side where bifurcation is prohibited. Therefore, CESR would like the IASB to consider further assessment in due course whether bifurcation of a hybrid contract with a financial asset host would provide users with more decision-useful information.
CESR agrees with EFRAG that changes in credit risk should not impact directly profit or loss for liabilities designated under the fair value option. It  agrees that fair value changes resulting from credit risk should not impact the income statement. This is in line with the response to the IASB’s discussion paper Credit Risk in Liabilities Measurement where it is stated that CESR believed the “subsequent measurement of financial liabilities should, in principle, not reflect changes in own credit risk”. Based on the feedback provided by users of financial information to the IASB and EFRAG, it seems an acceptable compromise to present these changes in Other Comprehensive Income (OCI).
The responses to the detailed questions are set out in the Appendix but to summarise our main concerns:
·         CESR believes that the proposal would create a mismatch for some companies (banks) where assets and liabilities are closely matched due to changes in assets going to profit or loss and some changes in liabilities going to OCI. A solution could be to allow the entire fair value change to go to profit and loss, when doing otherwise would create an accounting mismatch.
·         CESR thinks that the IASB should clarify the role of OCI and the income statement. CESR believes that some might still find it counter-intuitive that a positive impact on the balance sheet and in OCI might be recognised when the financial situation of the entity worsens.
The proposal only transfers the positive impact from net income to OCI. This raises a question regarding the role attributed to OCI. There was a broadly shared understanding that OCI had been intended to report movements that are outside control of the entity’s management (and as a consequence, the income statement reports movements that result from decisions taken by management).
CESR therefore has mixed views on EFRAG’s concerns regarding the two-step approach. CESR notes that reclassifying the impact of changes in credit risk into OCI would achieve more transparency than registering this impact directly in OCI. It, however, acknowledges that recognising debit and credit entries at the same time in the income statement might seems strange to some from a conceptual point of view.


© CESR - Committee of European Securities Regulators

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