Exposure draft zum RE-Exposure des IFRS 9

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Scot Leon Wilson
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1 IASB Division Bank and Insurance Austrian Federal Economic Chamber Wiedner Hauptstraße 63 P.O. Box Vienna T +43 (0) DW F +43 (0) E Mail: bsbv@wko.at Your ref., Your message of Our ref., person in charge Extension Date BSBV 2/Dr. Priester/Ha Exposure draft zum RE-Exposure des IFRS 9 The Division Bank and Insurance of the Austrian Federal Economic Chamber, as representative of the entire Austrian banking industry, appreciates the possibility to comment on the Exposure draft RE-Exposure of IFRS 9 and would like to submit the following position: We appreciate the efforts undertaken by the IASB to address specific application questions raised by interested parties, to take into account the interaction of the classification and measurement model for financial assets with the IASB s Insurance Contracts project and reduce key differences with the FASB tentative classification and measurement model for financial instruments. We believe the board has made progress on the proposed Classification and Measurement model. However, we still have some concerns with the ED. Pre-dominantly we encourage the Board to reconsider the following issues that are further explained in the appendix to this letter: The proposed amendment to the contractual cash flow characteristics assessment will mean that more assets may qualify for amortized cost accounting. However, relatively common features of financial instruments held in some jurisdictions are still likely to create the possibility of a significant difference in cash flows leading to measurement at FVTPL. The interpretation of not more than insignificantly is crucial for the decision to value a specific debt instrument at fair value or not in situations where a modified economic relationship exist. The current available operational application guidance is not sufficient especially in answering the question of when a detailed assessment has to be made or not. Due to operational reasons the initial assessment has to be performed on product level. A mandatory application of the new FVOCI category will increase again the complexity of measurement categories and would undermine the overarching goal to reduce the complexity ofthe current IAS ce_0_st_ifrs.docx - 1 -

2 The operational application guidance for the differentiation between FVOCI and FVTPL and between FVOCI and amortized cost is not clear enough. Amend IAS 39 so as to not further delay the benefit of increase relevance in the presentation of own credit risk in the financial statements. Appendix CONTRACTUAL CASH FLOW CHARACTERISTICS ASSESSMENT Question 1 Do you agree that a financial asset with a modified economic relationship between principal and consideration for the time value of money and the credit risk could be considered, for the purposes of IFRS 9, to contain cash flows that are solely payments of principal and interest? Do you agree that this should be the case if, and only if, the contractual cash flows could not be more than insignificantly different from the benchmark cash flows? If not, why and what would you propose instead? Notes 1. The ED proposes a minor amendment (Paragraphs B4.1.7-B4.1.9E) to the application guidance in IFRS 9 to clarify that if the contractual cash flows on a financial asset include only payments of principal and consideration for the time value of money and credit risk, but the economic relationship between these components is modified due to leverage or interest rate mismatch feature (a modified economic relationship), then an entity will have to assess the modification to determine whether the contractual cash flows represent solely payments of principal and interest on the principal amount outstanding. 2. The benchmark instrument is defined as a comparable financial asset, whether actual or hypothetical, that is identical in all respects with the financial asset being evaluated, except that it does not contain the modification in the economic relationship. 3. However in making such an assessment, an entity has to consider the cash flows of a comparable financial asset that is identical in all respects (including credit quality) except that it does not contain the modification to the economic relationship ( benchmark cash flows ). This would be the case if its cash flows are not more than insignificantly different compared to the cash flows resulting from a benchmark instrument. As a result, the instrument under assessment would fail the contractual cash flow characteristics assessment and would have to be measured at fair value through profit or loss (FVTPL). 4. The assessment described above would be performed by the holder on initial recognition, based on all available information (historical experience, current conditions and future forecasts) and applying judgment. Subsequently, it would not be reconsidered. 5. An entity need not perform a detailed assessment, but only if it is clear, with little or no analysis, that the cash flows on the financial asset could or could not be more than insignificantly different from the benchmark cash flows

3 6. In general we agree with the clarifications made to the contractual cash flow characteristics assessment. The proposed amendment to the contractual cash flow characteristics assessment will mean that more assets may qualify for amortized cost. However, relatively common features (e.g. interest mismatch between the rate term and fixation period, loans which do not have a rate term officially linked to the fixation period, state regulated interest rates,..) of financial instruments held in some jurisdictions especially in the emerging markets may create the possibility of a significant difference in cash flows. The amendments to IFRS 9 suggest to make a qualitative analysis first if the SPPI-criterion is not fully met. We agree with that approach especially under costs and benefits reflections. We have the following remarks here: o Loans with conditions (eg interest rates) prescribed by law (eg subsidised "Wohnbaudarlehen" or "Bauspardarlehen") shall not be judged by the SPPI-criterion. As long as the business model is "to hold and collect cash flows" these loans shall be measured at amortised costs. The same should apply if the average secondary marker yield of issued bonds (in Austria called SMR) or constant maturity swaps (CMS) is used to determine the base interest rate the instrument. o Deviations of the actual interest rate from the interest rate as of the interest rate fixing date do not prevent the instrument from beeing measured at amortised costs provided that the interval does not exceed what is customary in practice for these products, and there were no unusually large movements in interest rates in the respective period. o If the interest rate of the instrument in question does take into account liquidity costs (and the time value of money as well as the credit risk of the debtor) even the benchmark-instrument shall take such liquidity costs into account. This results in not making liquidity costs a deviation from the SPPI-criterion. 7. Comparison of the contractual cash flows with the benchmark cash flows can give different results if performed on different points in time e.g. interest rate set at month end, applied to loans for next interest period starting within whole following month. In case of high interest rate volatility following setting of interest rate until origination of the loan would cause comparison of actual cash flows with benchmark cash flows to differ more than insignificantly (resulting in FVTPL measurement). In contrast if volatility is low, comparison would result in decision to value at amortized cost. 8. Mismatch of interest term applied and fixation period e.g. 3 month rate applied to 1 month interest period could also yield different results of cash flows comparison based on different yield curve structures in specific points in time (flat yield curve versus normal yield curve structure). Changes in yield curve shape can result in different outcome of the same cash flow characteristics assessment applied in different point of time from different prepares of financial statements. Both situations (paragraph 7 and 8) should be clearly addressed as it can cause different treatment of the same products among prepares of financial statements although the same requirements are applied for the cash flow characteristics assessment. 9. From our point of view the interpretation of not more than insignificantly (i.e. How much the benchmark interest rate (market rate) may differ from the contractual interest rate) is crucial for the decision to value a specific debt instrument as described above in paragraph 7 and paragraph 8 at fair value or not. Here we are concerned that preparers of financial statements as well as the different auditors will interpret it in a different way which finally will lead to lack of transparency and comparability difficulties of financial statements

4 10. We believe that the IASB should carefully consider the above mentioned issues relatively common features in some jurisdictions which can lead to fair value measurement and the interpretation of not more than insignificantly - before finalizing the standard. In particular, we believe the IASB should specifically consider whether or not the information that would result from measuring those instruments at fair value through profit and loss would be more useful for users of financial statements. 11. We believe the use of amortized cost for debt instruments including features as mentioned in paragraph 6 provides superior information for users of financial statements in comparison to fair value measurement as long as the intention is to collect interest and to hold the originated loan until redemption. 12. Explicit exceptions should be made to instruments which have features which modify the economic relationship but may be measured at amortized cost or in the application guidance a more extensive list of examples need to be supplied which refer specifically to emerging markets. If the qualitative analysis results in the necessity to make a quantitative analysis (ie the qualitative analysis cannot bring the evidence of insignificant deviations from the SPPIcriterion), a benchmark-instrument has to be found and be compared to the instrument in question. Here we have the following remarks: o The comparison should not be made by reference merely to cash flows, but by comparing the present value of the cash flows of the instrument in question with the present value of the cash flows of the benchmark-instrument. o The result of this comparison depends on the expected interest rates used.the entity`s internal interest rate risk management should be used in determining which the reasonably expected interest scenarios are. This internal focus is also made by IFRS 9 (establishing the business model), and in the ED for IFRS 9 (General Hedge Accounting). o As long as there have been no significant changes in the interest environment, comparisons of this kind can be made for standard financial assets (products) in aggregate as well (adjusting for the relevant risk premium). 13. Finally we would like to point out that from our point of view the definition of interest is still quite unclear and judgmental, with the higher need of auditor involvement into the process of financial instruments classification and measurement. More detail explanation of possible components of interest rate (such as liquidity risk and profit margin) should be covered in IFRS 9. Also substantial judgment is needed to prove that modification is credit risk associated or presents time value of money if benchmark instrument not exist

5 Question 2 Do you believe that this Exposure Draft proposes sufficient, operational application guidance on assessing a modified economic relationship? If not, why? What additional guidance would you propose and why? 14. From our point of view the current available operational application guidance is not sufficient especially in answering the question of when a detailed assessment has to be made or not (B4.1.9E). 15. Further substantial judgment is needed to prove that modification is credit risk associated or presents time value of money when a benchmark instrument does not exist. Additional guidance in B4.1.8A should be included to clarify what is meant by unrelated. 16. We are concerned that the preparer of financial statements as well as the different auditors will interpret the current available guidance in IFRS 9 in different ways which finally will lead to inconsistent application by prepares. 17. Furthermore the assessment at initial recognition as proposed will lead to significant implementation efforts and resources needs due to the fact that the assessment described above has to be performed by the holder on initial recognition, based on all available information (historical experience, current conditions and future forecasts) and applying judgment. It is also unclear if this assessment has to be performed on transaction level or on product level. To relieve the operational burden we propose to include in the application guidance the clarification that the assessment can be applied on product level (e.g. all consumer loans or mortgage loans with the same interest feature have to be assessed once). 18. We would prefer an explicit test for assessing the modified economic relationship along the lines of the double-double test as already used in US GAAP. However this test would only need to be used after first establishing that it is more probable than not that the economic relationship will be modified. Question 3 Do you believe that this proposed amendment to IFRS 9 will achieve the IASB s objective of clarifying the application of the contractual cash flow characteristics assessment to financial assets that contain interest rate mismatch features? Will it result in more appropriate identification of financial assets with contractual cash flows that should be considered solely payments of principal and interest? If not, why and what would you propose instead? 19. See answer to question 1-5 -

6 BUSINESS MODEL ASSESSMENT Question 4 Do you agree that financial assets that are held within a business model in which assets are managed both in order to collect contractual cash flows and for sale should be required to be measured at fair value through OCI (subject to the contractual cash flow characteristics assessment) such that: a. interest revenue, credit impairment and any gain or loss on derecognition are recognized in profit orloss in the same manner as for financial assets measured at amortized cost; and b. all other gains and losses are recognized in OCI? If not, why? What do you propose instead and why? 20. In general we believe that IFRS 9 should be based on a limited number of measurement categories and provide a clear rationale for each of those categories, as this would result in more useful reporting information while making IFRS 9 easier to apply by preparers by avoiding complexity. 21. For the above reason, we believe that the measurement category at FVOCI should only be introduced in IFRS 9 as an option to avoid accounting mismatches like those arising for insurance companies. In our view entities should be able to elect at initial recognition to measure eligible financial assets at FVOCI if by doing so eliminate or reduce an accounting mismatch that would otherwise arise from measuring financial assets and the related liabilities on different bases. Question 5 Do you believe that the Exposure Draft proposes sufficient, operational application guidance on how to distinguish between the three business models, including determining whether the business model is to manage assets both to collect contractual cash flows and to sell? Do you agree with the guidance provided to describe those business models? If not, why? What additional guidance would you propose and why? Notes 22. IFRS 9 provides a mixed measurement model whereby a debt instruments (such as loans and debt securities) would be classified in one of the three measurement categories, based on their contractual cash flow characteristics assessment and the business model within which they are held. These are either at amortized cost, FVOCI or FVTPL. Financial assets that pass the contractual cash flow characteristics assessment, but fail either the business model criteria for FVOCI or amortized cost, would be classified as FVTPL, as a residual category. 23. The ED includes clarifications on financial assets allocated to the business model "Hold and Collect" (amortized cost). Sales due to credit deterioration out of the business model "Hold and Collect are allowed as long as the financial asset does not any longer correspond to the investment policy of the entity. 24. In addition, infrequent sales - even if they are significant - or insignificant sales - even if they are made on a frequent basis are compatible with the business model "Hold and - 6 -

7 Collect ". The only feature to distinguish the new business model, "Hold and Sell" from the business model "Hold and Collect is a higher frequency or a higher volume of sales. 25. We believe that the operational application guidance for the differentiation between FVOCI ( Hold and Sell ) and FVTPL and between FVOCI ( Hold and Sell ) and amortized cost ("Hold and Collect") are not clear enough. This concern is related to question how the business models test and the application guidance for the amortized cost measurement category will be interpreted, in particular, the nature, level and frequency of sales allowed. 26. Here we are concerned that the preparers of financial statements as well as the different auditors will interpret the guidance in different ways which finally will lead to inconsistencies in the market. From our point of view there should be included more application guidance to assess properly at the date of initial recognition of a financial asset which business model is adequate for the respective financial assets in question. We would especially welcome more guidance on the volumes and frequencies of sales are allowed and under what circumstances sales are does not lead to tainting leading to FVTPL or FVOCI measurement. 27. Furthermore we believe that the proposals in the ED would change the principles in IFRS 9 for the amortized cost measurement category and will restrict the use of amortized cost in the measurement of financial assets. In this respect, do not agree with paragraph BC30 in the ED, in particular, as we believe the transfer would be from amortized cost to FVOCI. 28. For the above reasons we believe that the measurement category at FVOCI should only be introduced in IFRS 9 as an option for companies to avoid accounting mismatches as already mentioned above in paragraph 16. Question 6 Do you agree that the existing fair value option in IFRS 9 should be extended to financial assets that would otherwise be mandatorily measured at fair value through OCI? If not, why and what would you propose instead? 29. We agree that the existing fair value option in IFRS 9 should be extended to financial assets that would otherwise be mandatorily measured at FV-OCI to eliminate, or at least mitigate, new accounting mismatches that could arise as a result of measuring eligible debt instruments at FV-OCI (e.g. the liability is measured at ATFVPL but the debt instrument at FV-OCI). 30. However as mentioned already in paragraph 16 above, we recommend to introduce the new FV-OCI category as an additional option in IFRS

8 EARLY APPLICATION Question 7 Do you agree that an entity that chooses to early apply IFRS 9 after the completed version of IFRS 9 is issued should be required to apply the completed version of IFRS 9 (i.e. including all chapters)? If not, why? Do you believe that the proposed six-month period between the issuance of the completed version of IFRS 9 and when the prohibition on newly applying previous versions of IFRS 9 becomes effective is sufficient? If not, what would be an appropriate period and why? 31. Considering the complexity arising from a phased application we agree with that after IFRS 9 is finalized, the early application of IFRS 9 should require to apply IFRS 9 in its entirety (except the own credit provisions; see paragraph 33). We also agree with the six-month transition period. OWN CREDIT PROVISIONS Question 8 Do you agree that entities should be permitted to choose to early apply only the own credit provisions in IFRS 9 once the completed version of IFRS 9 is issued? If not, why and what do you propose instead? 32. We believe that entities should be permitted to early apply the own credit provisions in IFRS 9. The application of the current requirements means that improving perceptions of an entity s creditworthiness reduces earnings, and worsening perceptions of creditworthiness increases earnings. Such counter-intuitive earnings volatility proved to be very large, particularly prepares of financial statements in banking industry. 33. Further we propose to amend IAS 39 so as to not further delay the benefit of increase relevance in the presentation of the financial statements. FIRST-TIME ADOPTION Question 9 Do you believe there are considerations unique to first-time adopters that the IASB should consider for the transition to IFRS 9? If so, what are those considerations? 34. We do not have any specific comments regarding first-time adopters. Kind regards, Dr. Franz Rudorfer Managing Director Division Bank & Insurance Austrian Federal Economic Chamber - 8 -

C/O KAMMER DER WIRTSCHAFTSTREUHÄNDER

C/O KAMMER DER WIRTSCHAFTSTREUHÄNDER SCHOENBRUNNER STRASSE 222 228/1/6 A-1120 VIENNA AUSTRIA Hans Hoogervorst Chairman International Accounting Standards Board 30 Cannon Street London EC4M 6XH United Kingdom