03 December 2013

IASB/Hoogervorst: Why the financial industry is different

Mr Hoogervorst discussed the IASB's work on replacing IAS 39. This work has taken a long time as financial instruments are such difficult terrain but he also added: "IFRS 9 will get done and it will get done soon".

There are two reasons why standard-setters are wrestling with financial instruments.

First, they are inherently very complicated. More importantly, the financial industry is extraordinarily sensitive to accounting rules. Relatively small changes in accounting rules can make a big difference to banks. Enthusiasm for greater transparency in accounting is greatly tempered by the possibility of this leading to further bank bailouts! So every change the IASB proposes is subject to intense scrutiny.

Why is this the case? What is it that sets the financial industry apart from other sectors of the economy when it comes to accounting?

The IASB has often been accused of being too focused on the balance sheet and on fair value measurement. This could allegedly lead to lack of prudence and excessive accounting volatility.

The IASB is fully aware that an uneven focus on the balance sheet would not provide the investor with useful information.

The financial industry is different. Banks and insurance companies have huge balance sheets and those balance sheets matter hugely. Relatively small changes in the balance sheet can have an enormous impact on earnings. Future cash flows are very much dependent on the financial instruments on banks’ and insurance companies’ balance sheets.

For many financial instruments, it is their current value that counts. Some are actively traded on financial markets and are therefore subject to market fluctuations. So the balance sheet and current measurement techniques, which include fair value accounting but are not limited to it, are much more important to the financial sector than to the non-financial sector.

It is exactly this undeniable importance of current measurement techniques that makes accounting for the financial industry so controversial. Current measurement is much better at picking up mismatches between assets and liabilities. It is also much more sensitive to market fluctuations.

As a result, current measurement is more likely to lead to volatility. In this respect, bankers and insurers are no different from all other preparers: they all hate volatility!

The financial crisis also led the IASB to accelerate its work to replace IAS39 with IFRS 9. In this Standard, the IASB is continuing with a mixed measurement approach, but the IASB has tried to put the criteria for classification and measurement on a more objective footing.

The classification of a financial instrument depends on both the nature of the cash flows and the business model. To put it roughly, if an instrument has basic loan features and the business model is to hold it for collection, it is measured at amortised cost. If an instrument does not have basic loan features and the business model is to trade the asset, it will be measured at fair value through profit and loss. If an asset is held both for selling and for collecting the contractual cash flows, it will be measured at Fair Value through OCI.

IASB's objective is to improve transparency, not to mask economic volatility. For that reason the IASB is treading very carefully in developing its proposals.

Since it is clear that it will still take significant time to finalise IASB's possible proposals on macro hedging, the IASB has separated it from the rest of IFRS 9. IFRS 9 is practically finished and will soon be ready to be endorsed. Because of the significant improvements that

Because of the significant improvements that IFRS 9 makes in classification and measurement, and also in general hedging and impairment, Mr Hoogervoorst has no doubt that it will be endorsed around the world.

Full speech

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