Re: Comments on ED/2012/4 Classification and Measurement: Limited Amendments to IFRS 9

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3 China Accounting Standards Committee April 11, 2012 Mr. Hans Hoogervorst Chairman International Accounting Standards Board 30 Cannon Street London, EC4M 6XH United Kingdom Dear Mr. Hans Hoogervorst, Re: Comments on ED/2012/4 Classification and Measurement: Limited Amendments to IFRS 9 Thank you very much for your care and kind support of the convergence between China Accounting Standards and International Financial Reporting Standards. We are pleased to have an opportunity to comment on the Exposure Draft ED/2012/4 Classification and Measurement: Limited Amendments to IFRS 9 ( the ED ) issued by the International Accounting Standards Board ( IASB or the Board ). Our main comments on the questions in the ED are summarized as follows: 1.We basically agree with the proposals in the ED regarding the classification of financial instruments. 2.We support the restrictions on early application proposed by the ED. 3.If the Board may consider postponing the effective date of IFRS 9 again, we would recommend that the standard on financial instruments shall have the same effective date as the standard on insurance. 4.We welcome the ED s proposal of adding more guidance on the classification of financial instruments. However, we are concerned that certain wordings in B of the ED might cause misinterpretation in China and hence recommend removing the example related to Instrument B in B so as to avoid any impact on the Tel: (86 10) Fax: (86 10)

4 continuous convergence between China Accounting Standards and International Financial Reporting Standards, reasons are as follows: Firstly, the interest rate is the price of capital, as the standards issued by the Board never require evaluating whether the pricing mechanism of resources in a specific market is fair or market based, neither should IFRS 9 require an evaluation of the interest rate formation mechanism in a specific country. Secondly, in China, all banks must abide by the rule that interest rates of loans from financial institutions shall be adjusted according to the central bank's benchmark interest rate. Consequently, there are no opportunities for arbitrage, because such interest rate only reflects the loan principal s time value of money and the consideration of credit risk in corresponding period, without taking into account the consideration of other factors, accordingly, there will be no interest rate mismatch. If you have any questions concerning our comments, please feel free to contact Mr. Leng Bing, Accounting Regulatory Department of the Ministry of Finance of China ( MOF ) ( , lengbing@mof.gov.cn). Yours sincerely, Yang Min [signed] Director General, Accounting Regulatory Department, MOF, China Secretary General, China Accounting Standards Committee Tel: (86 10) Fax: (86 10)

5 China Accounting Standards Committee of Ministry of Finance, China Comments on the IASB s Exposure Draft ED/2012/4 Classification and Measurement: Limited Amendments to IFRS 9 I. General Comments Our general comments and suggestions on the ED are as follows: 1. We support the IASB's proposal of adding a new category of debt instrument investments measured at fair value through other comprehensive income. However, we disagree with the guidance regarding the judgment of contractual cash flow characteristics. Please refer to our response to Question 2 for our detailed comments. 2. We suggest that the cost measurement exception under the existing International Accounting Standard 39 Financial Instruments: Recognition and Measurement (IAS 39) shall be retained. According to the existing IAS 39, if the fair value of equity instrument investments cannot be reliably measured, the equity instrument investments held shall be measured at cost. Since the IASB started its project of amending the standards on financial instruments in 2009, we have, in many occasions, urged the Board to retain this exception so as to enhance the applicability of International Financial Reporting Standards to emerging economies. In addition, we noted that the US Financial Accounting Standards Board (FASB) has also retained such exception in its Exposure Draft Financial Instruments Overall issued in February Therefore, we believe that the IASB should retain such exception for the purpose of increasing applicability as well as enhancing convergence. 3. We recommend that the reversal of the cumulative change in fair value of equity instrument investments measured at fair value through other comprehensive income shall be allowed. For equity instrument investments not held for trading, if they are elected to be measured at fair value through other comprehensive income on initial recognition, we recommend that, on derecognition, the Board shall allow the cumulative changes in fair value recognised in other comprehensive income to be released to profit or loss for the current period. This will be conducive to maintaining the inherent consistency of International Financial Reporting Standards. 4. We recommend that the same effective date shall be established for both the standards on financial instruments and the standard on insurance. If the Board considers further postponing the mandatory effective date of the standards on financial instruments which is currently scheduled on January 1, 2015, we recommend that the Board shall ensure that the standards on financial instruments and the standard on insurance shall have the same effective date. Tel: (86 10) Fax: (86 10)

6 II. Responses to the questions in the ED The following are our detailed comments on the questions in the ED. 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? Response: We 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 still be considered to contain cash flows that are solely payments of principal and interest. We agree that differences between contractual cash flows and benchmark cash flows being "not more than insignificant" is a criterion in principle when determining whether a modified economic relationship fulfills the contractual cash flow characteristics. However, we strongly disagree with certain specific guidance. Please refer to our comments on Question 3. 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? Response: We consider the guidance provided by the ED is not sufficient, and the meaning of "more than insignificant" is not clear enough. Consequently, it is difficult to consistently apply such guidance in practice. We recommend that the IASB shall provide more sufficient guidance on the interpretation of "more than insignificant" and the determination of benchmark instrument. 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 Tel: (86 10) Fax: (86 10)

7 flows that should be considered solely payments of principal and interest? If not, why and what would you propose instead? Response: Even though we believe that most of the guidance is conducive to IASB in achieving its objective, we strongly oppose to the examples included in some specific guidance. We conclude that related examples in the application guidance might be misleading in China and cannot be implemented. We noted that in the Agenda Paper 6B published by the IASB in October 2012, IASB staff conducted a more detailed discussion and reached a conclusion on how the above principle should be applied to "a country with interest rate regulation". In this context, one example in the application guidance B in the ED will be misleading. According to the example included in the Agenda Paper 6B, after a country s central bank announces a new loan interest rate, a 5 year loan that will be due in 1 year should bear the interest for the remaining 1 year using the interest rate applicable to a 5 year loan. Accordingly, the Agenda Paper 6B concluded that the related contractual terms would cause "the interest rate is reset, but the frequency of reset does not match the tenor of the interest rate", i.e., "interest rate mismatch". However, in China's situation, subject to the restraint of relevant laws and contractual terms, both banks and borrowers cannot choose any interest rate other than the benchmark interest rate announced by the central bank. Under such circumstances, interest rate still only reflects the principal s time value of money and the consideration for credit risk, without taking into account other factors. Accordingly, there are no opportunities for arbitrage. Therefore, we believe that in this case, the economic relationship between the interest rate and the time value of money and the credit risk has not been modified. Due to the above reasons, we suggest removing the 20 th row of the table on page 28 of the ED, i.e., the wording beginning from "Likewise, if " to the end of that example. From our point of view, such removal will not impair relevant guidance, but rather, it could avoid misleading users. Alternatively, in the sentence "Likewise, if " in the example of "instrument B", the Board could further clarify that if the borrower cannot choose other interest rate, the instrument would be qualified for the contractual cash flow characteristics for measurement at amortised cost. Similarly, we also suggest removing paragraph 44 of Basis for Conclusions of the Exposure Draft. 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 Tel: (86 10) Fax: (86 10)

8 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? Response: We agree with this proposal. 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? Response: We support the guidance provided by the ED, however, we are concerned that it is not sufficient enough. We suggest that more specific guidance or examples shall be provided for the following: (1) the frequency, timing and volume of sales; (2) the specific methods of judging whether the effect of changes in investment policy would result in the change of business model; (3) the specific approaches to determine the extent of disaggregation of investment portfolio that has components with the objective of selling and those with the objective of holding. In addition, we noted that the framework for distinguishing the three business models is, in effect, transferring the complexity of measurements in the existing standards on financial instruments (especially the complexity of impairment) to the complexity of classification. We are concerned that as impairment may be more "auditable" than classification, this might put auditors into an unfavorable position in relevant disputes with audit clients. Therefore, we encourage the Board to provide more sufficient and specific guidance on distinguishing the three business models in order to enhance the auditability of the new standard. 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? Tel: (86 10) Fax: (86 10)

9 Response: We agree with this proposal. 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? Response: We are basically supportive of this proposal. However, we d like to bring the IASB to the attention that the time lag between the early adoption of the new standard on financial instruments and the mandatory adoption of the new standard on insurance might cause potential "mismatch" for insurance companies. 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? Response: We support this proposal. We agree that the application of other versions of IFRS 9 shall not be allowed until the completed version of IFRS 9 is issued and becomes effective so as to avoid any confusion caused by multiple versions. However, for the changes in the fair value of financial liabilities designated as at fair value through profit and loss due to changes in own credit, the effect attributable to changes in own credit shall be recognised in other comprehensive income, early application shall be permitted separately from the completed version of IFRS 9. As the relevant requirements under the current IAS 39 indeed might cause outcome contradictory to the general principles, permitting separate early application of the above provision will be conducive to rectifying such error. 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? Response: We have not yet encountered any such issues. Tel: (86 10) Fax: (86 10)