The LIAJ s Comments on the ED. Classification and Measurement: Limited Amendments to IFRS 9

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1 The LIAJ s Comments on the ED Classification and Measurement: Limited Amendments to IFRS 9 Proposed amendments to IFRS 9 (2010) 28 March 2013 The Life Insurance Association of Japan (LIAJ) The Life Insurance Association of Japan (LIAJ) 1

2 Contents 1. General opinions on the exposure draft 1.1. General opinions of the life insurance industry on the accounting standard 1.2. Need for further amendment to some requirements in IFRS 9 in addition to the proposals in this exposure draft 1.3. Need for flexible approach in terms of the mandatory effective date 2. Responses to the questions 2.1. Contractual cash flow characteristics assessment: a modified economic relationship between principal and consideration for the time value of money and the credit risk Question Question Question Business model assessment: the 'fair value through other comprehensive income' measurement category for financial assets that contain contractual cash flows that are solely payments of principal and interest Question Question Question Early application Question Presentation of 'own credit' gains or losses on financial liabilities Question First-time adoption Question 9 The Life Insurance Association of Japan (LIAJ) 2

3 1. General opinions on the exposure draft 1. With our greatest respect to the continuing efforts of the International Accounting Standards Board (IASB) for financial instrument project, the Life Insurance Association of Japan (LIAJ) would like to extend our gratitude to the IASB for providing us with the opportunity to submit our comments on the exposure draft, Classification and Measurement: Limited amendments to IFRS 9, Proposed amendments to IFRS 9 (2010) (hereinafter referred to as the exposure draft ), published in November The LIAJ is a trade association comprised of all 43 life insurance companies operating in Japan. Its aim is to promote the sound development of the life insurance industry and maintain its reliability in Japan. We would like to respectfully request that the IASB carefully consider the comments submitted from the sole representative body of the life insurance industry in Japan, which holds the second largest life insurance market in the world. 1.1 General opinions of the life insurance industry on the accounting standard 3. The nature of life insurance business is to underwrite risks over a long period and requires insurers to firmly fulfil the obligations to policyholders, instead of gaining profits through changes in fair value of financial assets and liabilities they hold. Therefore, life insurers aim at long-term stable portfolio management in their investments. Furthermore, life insurers invest in a wide range of assets including foreign currency bonds, equities and investment trusts, in order to maintain the sound and well diversified portfolio. 4. Thus, we believe that it is not appropriate to recognise such short-term changes in fair value of assets held in life insurers portfolio in profit or loss Need for further amendment to some requirements in IFRS 9 in addition to the proposals in this exposure draft 5. The exposure draft proposes the introduction of the 'fair value through other comprehensive income (FVOCI)' measurement category and the requirement for reclassifying the amount recognised in other comprehensive income (OCI) to profit or loss once they are realised (known as recycling). Although these amendments are limited, we appreciate these proposals as they contribute to relevant presentation of life insurance business profile mentioned above to some extent. However, there are still outstanding issues which should be addressed, and we believe that the IASB needs to consider the following improvement: Expanding the scope of assets to be measured at FVOCI Eliminating the inconsistent requirement for recycling among assets to be measured at fair value through OCI arising from limited permission of recycling Reducing the undue disclosure requirements for an entity that elects to present the changes in fair value of equity instrument in other comprehensive income (so-called OCI option) Reconsidering the requirement regarding valuation of investments in equity instruments that do not have a quoted market price and whose fair value cannot be reliably measured The Life Insurance Association of Japan (LIAJ) 3

4 Ensuring sufficient convergence with FASB s proposals/standards (Expanding the scope of assets to be measured at FVOCI) 6. As stated above, the nature of life insurance business is to underwrite risks over a long period and it requires insurers to firmly fulfil the obligations to policyholders, instead of gaining profits through changes in fair value of financial assets and liabilities they hold. Therefore, in order to firmly fulfil obligation, life insurers generally invest in a wide range of investment assets including foreign currency bonds and investment trusts to achieve well diversified investment portfolio that ensures long-term stable revenue. 7. We are concerned that presenting short-term fluctuation in fair value including the one caused by changes in foreign exchange rate in profit or loss will cause misunderstanding among users. Therefore, we believe that entities should be allowed to measure wider range of assets using FVOCI measurement category so that insurance business profile would be appropriately presented to users, although currently it is limited to equity and certain types of debt instruments. (Eliminating the inconsistent requirements for recycling among assets to be measured at fair value through OCI arising from limited permission of recycling) 8. While for debt instruments categorised in newly introduced FVOCI measurement category, realized amounts are allowed to be recognised in profit or loss, as for equity instruments an entity elected to use OCI option in measuring them, entities would not be permitted to recycle gains or losses accumulated in OCI. The proposals would create inconsistency among requirements for recycling within IFRS We think that presenting the actual performance of an entity based on the realised gains or losses through profit or loss separately from the comprehensive income that presents all changes including unrealised gains or losses would provide users of financial statements with useful information. Thus, we believe that recycling should be done for all assets measured at fair value through OCI measurement category upon realization. 10. In addition, the treatment of OCI and recycling are described as a high priority issue in the IASB's Agenda Consultation, and the Feedback Statement on its Agenda Consultation 2011 published in December 2012 stated that the IASB has already started work on this section of the Conceptual Framework. As mentioned above, since the current IFRS 9 contains internal inconsistencies in treatment of recycling, we think that the IASB should redeliberate to eliminate these inconsistencies before the finalisation of IFRS 9. (Reducing the undue disclosure requirements for an entity applying OCI option) 11. In IFRS 7, an entity is required to disclose the fair value of each financial asset designated to apply OCI option in the notes to its financial statements. We believe that presenting fair value of each asset in detail (for example, for each issuer) at the end of the period would not be appropriate information to be disclosed in notes, as doing so might lead to detailed disclosure of proprietary information such as insurers' asset management strategy and investment policy. We believe that breakdown of the financial instruments by industry will be able to provide useful information that enables users to understand the overview or outline of the management strategy and accounting policy for investments. The Life Insurance Association of Japan (LIAJ) 4

5 (Reconsidering the requirements regarding valuation of investments in equity instruments that do not have a quoted market price and whose fair value cannot be reliably measured) 12. According to the current IFRS 9, an entity is required to measure all investments in unquoted equity instruments at fair value, except under limited circumstances. We understand that the Educational material on fair value measurement' describes the fair value measurement in such circumstances. However, we believe that measuring the equity instruments that do not have a quoted market price and whose fair value cannot be reliably measured, such as unlisted stocks, at fair value is not appropriate in terms of reliability and feasibility. Therefore, we think that the current IFRS 9 and the Educational material on fair value measurement need to be amended so that issues of reliability and feasibility would not arise. (Ensuring sufficient convergence with FASB s proposals/standards) 13. It should be noted that there are some key differences between IFRS 9 and the FASB's classification and measurement model for financial instruments, for example, relating to the fair value measurement of unlisted stocks mentioned above. If these differences have been left unresolved and both of IFRS and US GAAP end up diverged, it might be difficult for users to find incentive to replace IAS 39 with IFRS 9. Accordingly, we think achieving sufficient convergence with the FASB's proposals is essential in amending the accounting for financial instruments. Thus, we urge the IASB to reconsider IFRS 9 to develop sufficiently high quality accounting standards without limiting the scope of amendments to this exposure draft Need for flexible approach in terms of the mandatory effective date 14. The IASB has separated IFRS 9 (re)deliberation which is currently undertaken into 'classification and measurement', 'impairment', and 'general hedge accounting', and an entity would be required to mandatorily apply these requirements for annual periods beginning on or after 1 January However, we are concerned that there remain a number of outstanding issues even at this stage. 15. For example, the direction of deliberation about 'impairment' is significantly different from the proposals in the exposure draft 'Financial Instruments: Impairment', published in 31 January Our concern is that while it is necessary to ensure sufficient preparation timeframe for implementation, finalising 'impairment' project as IFRS is still under deliberation and the timing for finalization is unpredictable at this stage. Furthermore, in addition to the fact that it seems difficult to expect sufficient convergence with FASB's requirements on 'measurement of unlisted stocks' and 'impairment', there is a great number of issues to be resolved, including the issue of OCI and recycling that is considered as a high priority issue in the Agenda Consultation mentioned earlier. 16. In this context, it is not appropriate to set mandatory effective date of IFRS 9 for annual periods beginning on or after 1 January 2015, and to prohibit the application of the existing IAS 39 after that date. We believe that flexible approach, such as postponing mandatory effective date or permitting ongoing application of existing IAS 39, should be needed until those outstanding issues are resolved. 17. Also, as for insurers, there is a concern that insurers would be required to make two rounds of major changes in the measurement of both assets and liabilities, since the IFRS 4: Insurance contracts phase II is currently under deliberation. Besides, there might arise accounting The Life Insurance Association of Japan (LIAJ) 5

6 mismatches in the measurement of financial assets and insurance liabilities due to the difference in implementation periods for financial instruments and insurance contracts. Amendments to accounting standards for financial instruments that account for a large part of life insurers' assets and developments of the project for insurance contracts that account for a large part of life insurers' liabilities, would have a great impact on life insurers. Therefore, we believe that the effective date for IFRS 9 for entities that are likely to apply IFRS 4 Insurance contracts phase II should be set at the later timing of completion of IFRS 9 or completion of IFRS Responses to the questions 2.1 Contractual cash flow characteristics assessment: a modified economic relationship between principal and consideration for the time value of money and the credit risk 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? [No comment.] 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? 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? [With regards to Question 2 and 3, we welcome the proposed amendments except for detailed guidance such as B and B that illustrate examples of financial instruments.] 18. We appreciate the proposed amendment regarding the modified economic relationship between principal and consideration for the time value of money and the credit risk, since this would enable entities to reasonably assess contractual cash flow characteristics according to each entity's business practice, and thus, it would contribute to the appropriate recognition of financial instruments by entities. However, as paragraphs B and B provide detailed guidance that illustrates examples of financial instruments, we are concerned that this guidance appears to be too prescriptive when entities assess modified economic relationship. Therefore, we believe that due consideration should be given so that the guidance illustrating examples of The Life Insurance Association of Japan (LIAJ) 6

7 these instruments would not be too prescriptive. 2.2 Business model assessment: the 'fair value through other comprehensive income' measurement category for financial assets that contain contractual cash flows that are solely payments of principal and interest 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 recognised in profit or loss in the same manner as for financial assets measured at amortised cost; and (b) all other gains and losses are recognised in OCI? If not, why? What do you propose instead and why? [We agree with the proposal to introduce FVOCI measurement category, but do not agree with the scope of assets to be valued at FVOCI as it is limited only to particular debt instruments.] 19. The nature of life insurance business is to underwrite risks over a long period and requires insurers to firmly fulfil the obligations to policyholders, instead of gaining profits through changes in fair value of financial assets and liabilities they hold. We think life insurers need to appropriately present the nature of their business to users of the financial statements, and we are concerned that presenting in profit or loss unrealised gains and losses, e.g. changes in fair value of financial assets they hold, will cause misunderstanding among users. We agree with the proposal to introduce fair value through OCI measurement category for debt instruments and the recycling of gain or loss recognised in OCI to profit or loss when the instrument is derecognised. 20. On the other hand, in order to firmly fulfil obligation, it is essential for entities to generate long-term stable revenue by investing in a wide range of investment assets including foreign currency bonds and investment trusts in the light of diversified investment. Also, we are concerned that presenting short-term fluctuations in fair value or foreign exchange rate of these assets held for above mentioned purpose through profit or loss will cause misunderstanding among users. Therefore, for the purpose of appropriate presentation of insurance business profile for users, we urge the IASB to amend related paragraphs including paragraph of the IFRS 9 (2010), paragraph 5.7.1A of this exposure draft, and paragraph 28 of IAS 21, so that the scope of assets to be measured at FVOCI which is currently limited to equity (apply OCI option) and particular types of debt instruments (use of FVOCI measurement category) is expanded to wider range of assets such as foreign exchange gains and losses from foreign currency bonds and investment trusts, and gain or loss recognised in OCI can be recycled to profit or loss when the financial asset is derecognised 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 The Life Insurance Association of Japan (LIAJ) 7

8 guidance provided to describe those business models? If not, why? What additional guidance would you propose and why? [No comment.] 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? [No comment.] 2.3. 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 (ie 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? [We agree with the proposal on early application but do not agree with mandatory effective date, as we believe that the date needs to be set flexibly.] 21. We think that requiring an entity that, after the completed version of IFRS 9 is issued, elects early application of the completed version of IFRS 9 would contribute to the improved comparability in financial statements for users, compared to the current practice that permits entities to apply several accounting standards for financial instruments. 22. However, the IASB is currently undertaking its deliberation on IFRS 9 in separate phases, 'classification and measurement', 'impairment', and 'general hedge accounting', and an entity is required to mandatorily apply these requirements for annual periods beginning on or after 1 January However, we are concerned that there remain a number of outstanding issues even at this stage. 23. For example, the direction of deliberation about 'impairment' is undertaken significantly different from the proposals in the exposure draft 'Financial Instruments: Impairment', published in 31 January Our concern is that while it is necessary to ensure sufficient preparation timeframe for implementation, the finalisation of the 'impairment' project is still under deliberation and the timing for deliberation is unpredictable at this stage. Furthermore, in addition to the fact that it seems difficult to expect sufficient convergence with FASB's requirements on 'measurement of unlisted stocks' and 'impairment', there is a great number of issues need to be resolved, including the issue of OCI and recycling that is considered as a high priority issue in the Agenda Consultation mentioned above. 24. In this context, it is not appropriate to set mandatory effective date of IFRS 9 for annual periods beginning on or after 1 January 2015, and to prohibit the application of the existing IAS 39 after that date. We believe that flexible approach, such as postponing mandatory effective date or permitting ongoing application of existing IAS 39, should be needed until those outstanding issues are resolved. The Life Insurance Association of Japan (LIAJ) 8

9 25. Also, as for insurers, there is a concern that insurers would be required to make two rounds of major changes in the measurement of both assets and liabilities, since the IFRS 4: Insurance contracts phase II is currently under deliberation. Besides, there might arise accounting mismatches in the measurement of financial assets and insurance liabilities due to the difference in implementation periods for financial instruments and insurance contracts. Amendments to accounting standards for financial instruments that account for a large part of life insurers assets and developments of the project for insurance contracts that account for a large part of life insurers liabilities, would have a great impact on life insurers. Therefore, we believe that effective date for IFRS 9 for entities that are likely to apply IFRS 4 Insurance contracts phase II should be set at the later timing of completion of IFRS 9 or completion of IFRS Presentation of 'own credit' gains or losses on financial liabilities 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? 26. If an entity is permitted to present fair value changes attributable to changes in the credit risk of financial liabilities through OCI and not to recycle the fair value changes recognised in OCI to profit or loss when the liabilities are derecognised, we believe that conceptual and comparability concerns described below might arise and therefore, proposed requirements need to be amended: (Why we do not consider the proposal as appropriate.) The recycling is not permitted in the proposed requirement, and thus this might alter the fundamental nature of profit or loss We think that the guidance to measure objectively the fair value changes attributable to changes in the credit risk of financial liabilities is not sufficient at present, and thus, this might raise concerns in terms of comparability in financial statements. (Our proposals to amend requirements) The fair value changes attributable to changes in the credit risk of financial liabilities presented in OCI is not permitted to be recycled to profit or loss upon realisation. We are concerned that not permitting the recycling of these changes might result in realised gains or losses that would not be reflected in profit or loss at the recognition of liability which has extinguished prior to its maturity, and lead to alter the fundamental nature of profit or loss. Therefore, considering the relevance of the profit or loss (realised gains or losses) for many investors and analysts in assessing the performance of an entity, we believe that recycling should be permitted. We think that the guidance to measure objectively the fair value changes attributable to changes in the credit risk of financial liabilities is not sufficient at present, and thus, this might raise concerns in terms of comparability in financial statements. We believe that proposed requirements need to be complemented by examples of standardised method or guidance so that an entity can measure objectively the fair value changes attributable to changes in the credit risk of financial liabilities. The Life Insurance Association of Japan (LIAJ) 9

10 2.5 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? 27. As for insurers, there is a concern that insurers would be required to make two rounds of major changes in the measurement of both assets and liabilities, since the IFRS 4: Insurance contracts phase II is currently under deliberation. Besides, there might arise accounting mismatches in the measurement of financial assets and insurance liabilities due to the difference in implementation periods for financial instruments and insurance contracts. Amendments to accounting standards for financial instruments that account for a large part of life insurers' assets and developments of the project for insurance contracts that account for a large part of life insurers' liabilities, would have a great impact on life insurers. Therefore, we believe that effective date for IFRS 9 for entities that are likely to apply IFRS 4 Insurance contracts phase II should be set at the later timing of completion of IFRS 9 or completion of IFRS 4. The Life Insurance Association of Japan (LIAJ) 10