11 September Our ref: ICAEW Rep 100/09. Your ref:

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1 11 September 2009 Our ref: ICAEW Rep 100/09 Your ref: Sir David Tweedie Chairman The International Accounting Standards Board First Floor 30 Cannon Street London, EC4M 6XH Dear Sir David FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT The Institute of Chartered Accountants in England and Wales (the Institute) is pleased to respond to your request for comments on Exposure Draft ED/2009/7 Financial Instruments: Classification and Measurement. Please contact me should you wish to discuss any of the points raised in the attached response. Yours sincerely Dr Nigel Sleigh-Johnson Head of the Financial Reporting Faculty T +44 (0) F +44 (0) Chartered Accountants Hall T +44 (0) PO Box 433 Moorgate Place London EC2P 2BJ UK F +44 (0) DX 877 London/City

2 ICAEW REPRESENTATION ICAEW REP 100/09 FINANCIAL INSTRUMENTS: CLASSIFICATION AND MEASUREMENT Memorandum of comment submitted in September 2009 by The Institute of Chartered Accountants in England and Wales, in response to the International Accounting Standard Board s Exposure draft ED/2009/7 Financial Instruments Classification and Measurement published in July 2009 Contents Paragraph Introduction - 1 Who we are - 2 Major points 5-27 Answers to specific questions

3 INTRODUCTION 1. The Institute of Chartered Accountants in England and Wales (the Institute) welcomes the opportunity to comment on Exposure Draft ED/2009/7 Financial Instruments: Classification and Measurement, published by the International Accounting Standards Board in July WHO WE ARE 2. The Institute operates under a Royal Charter, working in the public interest. Its regulation of its members, in particular its responsibilities in respect of auditors, is overseen by the Financial Reporting Council. As a world leading professional accountancy body, the Institute provides leadership and practical support to over 132,000 members in more than 160 countries, working with governments, regulators and industry in order to ensure the highest standards are maintained. The Institute is a founding member of the Global Accounting Alliance with over 775,000 members worldwide. 3. Our members provide financial knowledge and guidance based on the highest technical and ethical standards. They are trained to challenge people and organisations to think and act differently, to provide clarity and rigour, and so help create and sustain prosperity. The Institute ensures these skills are constantly developed, recognised and valued. 4. Our members occupy a wide range of roles throughout the economy. This response was developed by the Financial Reporting Committee of the Institute, which includes preparers, analysts, standard-setters and academics as well as senior members of accounting firms and public sector bodies. MAJOR ISSUES The approach to reform A phased approach 5 Whilst the ideal scenario would be for such a fundamental revision of IAS 39 Financial Instruments: Recognition and Measurement to be completed as one comprehensive exercise, we understand why a piecemeal approach has been adopted. This approach aims to address the areas of greatest concern, primarily the accounting for impairment of available-for-sale (AFS) assets and move toward reducing complexity in time for 2009 yearend reporting. We support such an approach rather than making quick changes for 2009 which are not aligned to the longer-term direction of financial instrument accounting. 6 However, the move to respond quickly to calls for change should not undermine the need to develop high quality standards, should not result in decisions that pre-empt other projects such as performance reporting and will require careful consideration of transitional provisions. We are concerned that the pace of change for financial instruments could result in decisions pre-empting other projects or where the implications have not been fully considered in two areas: the classification of financial liabilities coupled with the removal of the concept of embedded derivatives for liabilities and the classification of equity securities. Financial statement presentation 7 Several of our concerns in relation to the proposals are linked to the lack of progress of the financial statement presentation project in dealing with key issues relating to the classification of all gains and losses and how they are presented. We are not convinced, for example, that introducing another category, fair value through Other Comprehensive Income (OCI), is an improvement to financial reporting. It would be preferable for the IASB

4 to complete the financial statement presentation project and articulate the purpose of OCI (if it continues as a category) and the types of gains and losses that should to be presented there. At that stage, we would be in a better position to determine whether it is appropriate to fair value certain financial instruments through OCI or not. We do not support decisions on financial statements being made on a standard by standard basis before there is an agreed understanding of the purpose of OCI and whether or not recycling is required. We raise this issue in various places in responding to the proposals. Convergence with US GAAP 8 To achieve convergence with the Financial Accounting Standards Board (FASB), the respective financial instruments projects would need to operate in tandem. This is not possible given the IASB s current timetable but if there were fundamental differences between the two financial reporting standards it would be regrettable. Nevertheless, we support the IASB in developing a suitable, high quality standard based on a mixed measurement approach. 9 We do not support the broad direction of the FASB s approach, which is not a mixed measurement model. In our view, where amortised cost provides more useful information, reflecting the way the business is managed and the nature of the instrument, amortised cost should be used in both profit or loss and in the statement of financial position. Measuring items at fair value in the statement of financial position but at amortised cost in profit or loss with the difference included in OCI is not only complex and likely to cause confusion, but will result in less useful information in the statement of financial position in situations where amortised cost is the more relevant measure. We agree that some users are interested in the fair values of all financial instruments, but believe that this information is more appropriately provided in the notes. We would not support including fair value information on the face of the statement of financial position, even as a note item, where it is not the most relevant measure. Classification of liabilities 10 There are currently three basic categories for financial assets: amortised cost, fair value through profit or loss and fair value through OCI but only two categories for financial liabilities. Creating only two categories for both financial assets and liabilities with the same classification requirements and removing the concept of embedded derivatives has some merits and arguably reduces complexity. However, it potentially results in additional financial liabilities being measured at fair value through profit or loss. In our view, amortised cost provides a better indication of the expected future cash flows arising from liabilities, in particular those long-term liabilities that fund the business, than fair value. We are concerned that the classification for liabilities be fully thought through since the debt/equity project could result in additional liabilities, that are currently considered to be equity, being classified as liabilities. Some features which are not considered to be basic loan features because they result in variability in cash flows for the holder of the instrument are similar to equity features for the issuer, for example, the ability to defer interest without resulting in default in the case of certain subordinated liabilities or conversion features which are outside the scope of IAS 32 Financial Instruments: Presentation. It seems anomolous for equity to be at cost and some subordinated liabilities to be at amortised cost but other subordinated liabilities with equity-like features to be at fair value. 11 Concerns have been raised about recognising gains and losses as a result of changes in the entity s own credit risk as a result of the use of fair value. These are being are being considered through the recent discussion paper on credit risk in liability measurement. We suggested that fair value movements relating to own credit could possibly be included in OCI rather than profit or loss in response to the discussion paper. As already stated, we do not support decisions on performance reporting being made on a standard by standard

5 basis before there is an agreed understanding of the purpose of OCI and whether or not recycling is required. 12 Presenting gains and losses on own credit in OCI also does not address all our concerns about liabilities being measured at fair value. The ED would require the issuer in a structure resulting in mutiple contractually subordinated interests to fair value all but the most senior liability arising from the structure. For example, if a bank undertakes a securitisation to fund a portfolio of mortgages which are measured at amortised cost, the mortgages are not derecognised and the securitisation vehicle is consolidated, some of the tranches of liability that are external to the group would be measured at fair value. We do not think that the use of the fair value option to eliminate the resulting accounting mismatch is a satisfactory solution not least because there could be a timing difference between originating the mortages and the securitisation. On the face of it, the contractual liability of the issuer is unaffected by any credit protection in the structure. It may be possible to address the problem by making the unit of account in this situation the entire liability that is external to the group. However, it seems to us that there are some significant issues with the treatment of liabilities that may need some additional time to resolve. 13 We also believe that further work is required on the measurement attributes for liabilities more generally. As set out in our response to the fair value measurement ED, we are not convinced that liabilities should be measured using an exit price when a current measurement is appropriate but rather that a settlement notion is preferable to a transfer notion for liabilities that will, in fact, be settled. Before the number and types of liabilities that will be measured at fair value is expanded, consensus should be built around the appropriate measurement attributes for liabilities and the direction of the project to replace IAS 37 Provisions, Contingent Liabilities and Contingent Assets for non-financial liabilities should be considered to ensure that there is consistency in measurement where this is appropriate. 14 Therefore, we question whether it is appropriate, at this stage, to fully align the classification requirements for financial assets and liabilities. If additional time is needed to consider further all the issues that arise from applying the basic loan feature criteria to liabilities, it would be preferable not to include liabilities in the standard expected to be available for Embedded derivatives 15 We agree with the proposal of a single classification approach for hybrid contracts with financial hosts. This avoids the complexity surrounding the concept of embedded derivatives that has led to differences of opinion in identification of these and the attendant measurement issues. However, the subject of embedded derivatives cannot be disassociated from the accounting treatment of credit risk in liability measurement and the distinction between debt and equity. Therefore, in the short term (the financial reporting standard that will be available for use in 2009) we suggest that the existing requirements for financial liabilities be retained as noted above. While this does not reduce complexity in the short term, it would allow a more complete debate around the classification and measurement of financial (and non-financial) liabilities which we consider would improve the quality of the final financial reporting standard. Equity securities 16. Similarly, the idea of fair valuing equity securities though OCI, including dividends with no recycling, also potentially pre-empts decisions on financial statement presentation in areas outside the scope of financial instruments, such as pension accounting. As stated above, we do not support decisions on financial statement presentation being made on a standard by standard basis before there is an agreed understanding of the purpose of OCI and whether or not recycling is required. It may be preferable to delay creating such a new

6 category before the project on performance reporting is further advanced. In the very short term, it may be preferable to retain AFS for equity securities and directly address the issues with impairment, for example, to permit reversal of losses through profit or loss and adopting an impairment approach based on the lower of cost and fair value, rather than trying to progress this new category in the time available. 17. Again, therefore, the IASB should consider retaining the existing IAS 39 requirements with very limited changes in order to address the key areas of concern for 2009 year ends and thereby avoid pre-empting decisions on other, cross-cutting projects. Having additional time to debate these issues would result in higher quality standards in the longer term. Classification process 18 We support a mixed measurement approach which we agree provides better information on expected future cash flows when financial instruments are held to generate predictable flows rather than being traded. We also agree that, while the business model is important, classification cannot be based only on the business model. Therefore, we agree with the two step approach which looks at both the technical characteristics of the instrument as well as the entity s business model. It may aid understanding to reverse the order of the steps and put the business model as the first criterion. This would not necessarily change outcomes but would be more in keeping with how the requirements are likely to be applied in practice. 19 The principles underlying basic loan features and managed on a contractual yield basis should be stated more clearly. It would be helpful to ensure it is clear that the examples are just that, merely examples. We suggest that having some more sophisticated examples together with a full analysis of how the example fits with the principles would also help clarify the principles. 20 We have a number of concerns regarding the likely impact of the approach to classification in the ED. These relate to: the treatment of multiple contractually subordinated interests (tranches) where we support distinguishing tranches based on the principle of basic loan features but not the rule-based nature of stating that only the most senior tranche has basic loan features. This approach opens up significant structuring opportunities and it is difficult to see how they can be reduced without looking inside the structure to the underlying assets; and the requirement that all loans purchased with incurred credit losses must be managed on a fair value basis. We do not agree with the requirement since it is possible to purchase loans with incurred losses, perhaps as part of a business combination or loan portfolio purchase where the incurred losses cannot be specifically identified and the portfolio will be managed for their contractual cash flows in the same way as originated loans. We do not agree that the current market value of such loans is relevant to the consideration of whether the loans have basic loan features but where loans with incurred losses are purchased for trading, fair value would be appropriate. 21 We are also concerned that the criteria set by the ED may result in some financial instruments that are better accounted for at amortised cost being measured at fair value, in particular financial liabilities. In our view, unless the financial liability is held for trading, amortised cost provides a better indication of the expected future cash flows arising under a liability than fair value. Concerns have been raised about recognising gains and losses as a result of changes in the entity s own credit risk as a result of the use of fair value. These are being addressed by the recent discussion paper on credit risk in liability measurement. In response to the discussion paper, we suggested that fair value movements relating to own

7 credit could be included in OCI rather than profit or loss. However, the projects on debt/equity and financial statement presentation are also relevant to the treatment of financial liabilities. As already stated, we do not support decisions on performance reporting being made on a standard by standard basis before there is an agreed understanding of the purpose of OCI and whether or not recycling is required. Therefore, we do not believe it is appropriate, at this stage, to align the classification requirements for financial assets and liabilities. Reclassification 22 In our view, reclassification should be required if the business model changes, although reclassification should be restricted to financial instruments with basic loan features. Reclassifications would be expected to be infrequent and should be accompanied by sufficient disclosure to explain why the business model has changed and the measurement consequences We consider that it should be made clear that reclassification is the result of a fundamental change in the business as a result of a specific internal or external factor with disclosures to explain these factors and how they have changed the business model. Examples of factors that would result in a demonstrable change in the business model include acquisitions and disposals which result in the entity entering or leaving the market for a certain product or in a certain geography. As illustrated by recent history, there can also be profound shifts in the market that result in demonstrable changes to an entity s business structure, personnel and reported strategy which can be differentiated from trade versus hold decisions at the level of an individual instrument. We believe that the standard should be drafted along these lines and could be sufficiently robust to avoid abuse. Fair value option 23 We agree that entities should continue to be permitted to designate any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces an accounting mismatch. However, proposals in the exposure draft on hedge accounting may reveal a need for a revised fair value option. In addition, for the insurance industry financial instruments classification will depend on the requirements for measurement of insurance contracts when the insurance project is complete. Transitional arrangements 24 The transitional provisions in a phased approach need particular attention. For example, the insurance industry has concerns about how changes to classification and measurement of financial assets will operate before phase 2 of the insurance project is finalised and additional transition provisions may be needed such as re-opening the fair value option. Also, it should be made clear by the IASB that its intention is that an entity early adopting the standard on classification and measurement will not be disadvantaged. This would involving being able to change decisions on the fair value option when implementing the revised hedge accounting provisions and not being required to early adopt the later phases of the financial instrument project if an entity adopts the first phase. 25 In addition, the proposed transitional provisions are impracticable. It is unclear as to what is meant by the date of initial application. Paragraph 25 of the ED requires a financial asset or financial liability to be assessed for classification at the date of application and then to apply that classification retrospectively. This would require comparatives to be restated. Given the number of exemptions from the full retrospective application set out in the ED, it appears to us that the comparatives would not be comparable or provide very useful information. It would seem logical that the precedent established in IFRS 1 First-Time Adoption of International Financial Reporting Standards for transition to IAS39 be followed in the new standard. This would require the closing balance sheet of the previous period to be restated as the opening balance sheet of the period of adoption together with explanations for the main changes in classification and measurement. This disclosure

8 should be required for all adopters and seems to provide better, more understandable information to users about the impact of the transition than attempting to restate comparatives. Disclosures 26 We do not agree with the additional disclosure requirements proposed for entities that apply the proposed IFRS before its mandated effective date. The disclosure of early adoption of the new standard together with the adjustments to the opening balance sheet suggested above should be sufficient. IASB Alternative Views 27 We do not believe that the alternative approach or either of its possible variants would provide more decision useful information. In our view it is not in line with an entity s business model to recognise fair value in its statement of financial position for financial instruments that are not held for trading or managed on a fair value basis. IFRS7 Financial Instruments: Disclosures paragraph 25 requires disclosure of fair value by class in a way that permits comparison with the carrying amount. SPECIFIC QUESTIONS Question 1 Does amortised cost provide decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis? If not, why? 1.1 Yes. Amortised cost provides decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis. Question 2 Do you believe that the exposure draft proposes sufficient, operational guidance on the application of whether an instrument has basic loan features and is managed on a contractual yield basis? If not, why? What additional guidance would you propose and why? 2.1 No. We believe that improvements should be made to the terminology and the operational guidance to better articulate the underlying principles and make sure the requirements are clearly stated and thus can be applied robustly in practice. Basic loan features 2.2 The description of a basic loan feature does not provide a definitive answer to what is and what is not meant by the term. A clearly articulated principle that can be consistently applied is necessary to ensure that this aspect of the ED can be made operational. 2.3 The drafting should make it clear that B3 contains only examples of basic loan features, and avoid details that appear to restrict the types of permissible interest. For example, mentioning quoted or observable interest rates in B3 (iii) could be read as restricting the application of the paragraph to prevent banks standard variable rates being basic loan features. 2.4 We have a number of specific concerns with the guidance, as follows:

9 The basic loan features criteria should clearly include receivables and payables that do not include interest and perpetual instruments. Adjustments for changes in the rate of inflation should be mentioned as a basic loan feature. The exposure draft refers to "quoted" or "observable" interest rates in B3(a)(iii). It is not clear from this description that a bank specific prime rate or standard variable rate would meet the requirements of a "quoted" or "observable" rate. We suggest that such rates are explicitly included as basic loan features. There are currently a number of structured loan products where the coupon is adjusted by the difference between two reference rates (for example, 5 year swap rate versus 10 year swap rate). Many of these are accrual accounted on the basis that the embedded derivative meets the closely related test. These products will fail the basic loan features test as they do not meet the "single referenced.rate test required by B3 (a) (iii) although they are held in portfolios managed for contractual yield. We believe further consideration be given as to whether it is appropriate to move these to a fair value basis. Changes in taxation or law that protect the borrower should be allowed as well as changes that protect the lender, given that contractual terms that change the timing or amount of payments are generally there to protect one or both of the parties to the contract. The ideas in paragraphs B1 and B3 should be unbundled to clarify in which cases features that protect the creditor, the debtor or both parties are consistent with basic loan features. Change in control clauses should be addressed and, as noted above, we consider that further thought should be given to whether the issuer s ability to change the timing or amount of payments, which is an equitylike feature, should fail basic loan features for the issuer. Extension terms should also be basic loan features if prepayment terms are deemed to meet the criteria. It is not clear whether contracts that create financial instruments but that also contain features such as providing cash back or loyalty points have basic loan features. The discussion in B6 and BC 26 refers only to secured or senior liabilities ranking above general creditors. It is not clear whether liabilities that are subordinated to general creditors or that are entitled only to a specified pool of assets have basic loan features, although we believe that such instruments should be considered to have basic loan features. A liability that has been created with features that result in it absorbing losses is equity-like for the issuer, although it could result in variability in cash flows for the holder. We question whether the emphasis on contractual terms to determine basic loan features could result in operational issues with contractual terms that are unsubstantive or that are not expected to apply in a going concern situation. This may be a particular issue for liabilities. 2.5 Overall, we are concerned that the classification for liabilities may require further consideration since the debt/equity project could result in additional items, that are currently considered to be equity, being classified as liabilities. Some features which are not considered to be basic loan features because they result in variability in cash flows for the holder of the instrument are similar to equity features for the issuer, for example, the ability to defer interest without resulting in default in the case of certain subordinated liabilities or

10 conversion features which are outside the scope of IAS 32. It seems anomolous for equity to be at cost and some subordinated liabilities to be at amortised cost but other subordinated liabilities with equity-like features to be at fair value. Consideration should be given to whether such features should be included in basic loan features for the liability. Managed on a contractual yield basis 2.6 We believe that the criteria for managed on a contractual yield basis need to be more clearly defined if they are to be made operational. We have a number of specific concerns, as follows: The criteria could be difficult to apply to liabilities and liquidity portfolios. A better criterion could concentrate on the instrument being held primarily for the receipt or payment of contractual cash flows. The wording should not inadvertently prevent hedged items being included. Paragraphs B13(b)and BC29 put forward inconsistent reasons why financial assets acquired at a discount that reflects incurred credit losses cannot be measured at amortised cost. We do not agree with the logic of either reason. - If loans contained basic loan features at origination, in the absence of any change to the underlying contracts, the loans will continue to contain basic loan features even if those loans have incurred credit losses. - Whether or not a portfolio is managed on a contractual yield basis is a matter of fact. Loan portfolios may be acquired either directly or as part of a business combination where there are incurred losses in the portfolio which cannot be specifically identified. It seems reasonable that such portfolios are managed on a contractual yield basis. On the other hand, deeply discounted loans may be acquired as part of an operation that is not managed on a contractual yield basis. The managed on a contractual yield basis criteria should be sufficient to result in the appropriate classification. - We also note that the use of the term incurred losses could be confusing, particularly if the term is no longer used in impairment in the future. We have assumed that the intention was to refer to actual losses or defaults. We do not think it would be operational to try to differentiate deep discounts from other secondary market movements and, therefore, are of the view that this issue can only be addressed through application of the business model. Question 3 Do you believe that other conditions would be more appropriate to identify which financial assets or financial liabilities should be measured at amortised cost? If so, (a) (b) (c) what alternative conditions would you propose? Why are those conditions more appropriate? if additional financial assets or financial liabilities would be measured at amortised cost using those conditions, what are those additional financial assets or financial liabilities? Why does measurement at amortised cost result in information that is more decision-useful than measurement at fair value? if financial assets or financial liabilities that the exposure draft would measure at amortised cost do not meet your proposed conditions, do you think that

11 those financial assets or financial liabilities should be measured at fair value? If not, what measurement attribute is appropriate and why? 3.1 As set out in 1.1 above, amortised cost provides decision-useful information for a financial asset or financial liability that has basic loan features and is managed on a contractual yield basis. It is also our view that, unless the financial liability is held for trading or otherwise managed on a fair value basis, amortised cost provides a better indication of the expected future cash flows arising from the liability than fair value. On a going concern basis, the entity will have to pay the liability in full and the current fair value is not the best indication of the amount payable. Entities are not usually in a position to trade their liabilities and concerns have not been raised about the current dividing line between amortised cost and fair value for liabilities. Issues such as the treatment of own credit with respect to financial liabilities at fair value are still unresolved and while these could be alleviated through presentation, this is not sufficient to address all the issues. 3.2 However, we support the two step approach set out in the ED for financial assets which, provided our areas of concern are addressed, would result in financial assets being measured appropriately. Question 4 (a) Do you agree that the embedded derivative requirements for a hybrid contract with a financial host should be eliminated? If not, please describe any alternative proposal and explain how it simplifies the accounting requirements and how it would improve the decision-usefulness of information about hybrid contracts. 4.1 We agree with the proposal of a single classification approach for hybrid contracts with financial hosts. This avoids the complexity surrounding the concept of embedded derivatives that has led to differences of opinion in identification of these and the attendant measurement issues. However, the subject of embedded derivatives cannot be disassociated from the accounting treatment of credit risk in liability measurement and the distinction between debt and equity. Therefore, in the short term (the financial reporting standard that will be available for use in 2009) we suggest that the existing requirements for financial liabilities be retained. While this does not reduce complexity in the short term, it would allow a more complete debate around the classification and measurement of financial liabilities which we consider would improve the quality of the final financial reporting standard. (b) Do you agree with the proposed application of the proposed classification approach to contractually subordinated interests (ie tranches)? If not, what approach would you propose for such contractually subordinated interests? How is that approach consistent with the proposed classification approach? How would that approach simplify the accounting requirements and improve the decision usefulness of information about contractually subordinated interests? 4.2 We do not agree with the application of the proposed classification approach to tranches. In particular, we are not convinced that: permitting only the most senior tranche to be measured at amortised cost is operational or provides the most useful information; requiring the issuer to fair value portions of the liability provides the most useful information as set out below.

12 4.3 We also believe there may be merit an approach that looks through to the underlying pool of assets and permits the related note to have basic loan features if: (a) (b) (c) the underlying assets have basic loan features; any derivatives in the structure do not result in additional leverage; and the variability of the cash flows to which the entity holding the note is exposed is similar to or less than that to which it would be exposed if it held the underlying assets. 4.4 The ED would require the issuer in a structure resulting in mutiple contractually subordinated interests to fair value all but the most senior liability arising from the structure. For example, if a bank undertakes a securitisation to fund a portfolio of mortgages which are measured at amortised cost, the mortgages are not derecognised and the securitisation vehicle is consolidated, some of the tranches of liability that are external to the group would be measured at fair value. We do not think that the use of the fair value option to eliminate the resulting accounting mismatch is a satisfactory solution not least because there could be a timing difference between originating the mortages and the securitisation. On the face of it, the contractual liability of the issuer is unaffected by any credit protection in the structure. It may be possible to address the problem by making the unit of account in this situation the entire liability that is external to the group. However, it seems to us that there are some significant issues with the treatment of liabilities that may need some additional time to resolve. Question 5 Do you agree that entities should continue to be permitted to designate any financial asset or financial liability at fair value through profit or loss if such designation eliminates or significantly reduces an accounting mismatch? If not, why? 5.1 Yes. If entities adopt a financial reporting standard based on this ED before the final requirements for financial instruments are issued, it may be necessary to allow entities to re-consider their use of the fair value option on transition to the final requirements. In addition, a similar re-consideration of the fair value option may be needed for insurers when the final standard on insurance contracts is applied. Question 6 Should the fair value option be allowed under any other circumstances? If so, under what other circumstances should it be allowed and why? 6.1 At this stage, it seems logical that the fair value option is only needed to address accounting mismatches. However, as the requirements in other areas, for example, hedge accounting, become clearer, it may be apparent that a wider fair value option is necessary. 6.2 If the existing requirements for financial liabilities are retained in the short term, this would retain the existing requirements for bifurcation of embedded derivatives. Question 7 Do you agree that reclassification should be prohibited? If not, in what circumstances do you believe reclassification is appropriate and why do such reclassifications provide understandable and useful information to users of financial statements? How would you account for such reclassifications, and why?

13 7.1 We do not agree that reclassification should be prohibited. Reclassification should in fact be required if the business model changes, although reclassification should be restricted to financial instruments with basic loan features and reclassifications would be expected to be infrequent and should be accompanied by sufficient disclosure to explain why the business model has changed and the measurement consequences. Examples of factors that would result in a demonstrable change in the business model include acquisitions and disposals which result in the entity entering or leaving the market for a certain product or in a certain geography. As illustrated by recent history, there can also be profound shifts in the market that result in demonstrable changes to an entity s business structure, personnel and reported strategy which can be differentiated from trade versus hold decisions at the level of an individual instrument. Since IFRS 5 Non-current Assets Held for Sale and Discontinued Operations excludes financial instruments from the scope of the measurement provisions, reclassification from amortised cost to fair value can be important, particularly where portfolios are held for sale and the fair value less cost to sell is less than amortised cost. In some circumstances, reclassification may help reduce the accounting mismatch if liabilities arising from securitisations are required to be measured at fair value and the securitised assets were categorised at amortised cost on origination. 7.2 We agree that it is not appropriate for reclassification where the fair value option has been applied. We also consider that it should be made clear that reclassification is the result of a fundamental change in the business as a result of a specific internal or external factor with disclosures to explain these factors and how they have changed the business model. 7.3 We specifically disagree with the Board s view that prohibiting reclassification will enhance comparability. This could result in two entities with the same business model managing a financial instrument in exactly the same way but required to use different measurement bases. It is difficult to see how this mismatch enhances comparability. Question 8 Do you believe that more decision-useful information about investments in equity instruments (and derivatives on those equity instruments) results if all such investments are measured at fair value? If not, why? 8.1 We agree that some users believe more decision-useful information about investments in equity instruments can result if all such investments are measured at fair value However, we have concerns whether all entities are able to determine reliable fair values in all circumstances and, therefore, think that the costs of obtaining a reliable fair value may exceed the benefits in some situations, particularly for smaller entities. Question 9 Are there circumstances in which the benefits of improved decision-usefulness do not outweigh the costs of providing this information? What are those circumstances and why? In such circumstances, what impairment test would you require and why? 9.1 Yes. If a reliable fair value cannot be obtained, the costs seem likely to exceed the benefits of using fair value. This may be more likely to be the case for smaller entities. We are not aware of any particular concerns with the existing provisions of IAS 39 in this area and suggest that paragraph 66 should be retained. Our discussions with users in the UK indicate that they do not believe such information is important enough for their understanding of the financial statements to warrant the cost and effort involved.

14 Question 10 Do you believe that presenting fair value changes (and dividends) for particular investments in equity instruments in other comprehensive income would improve financial reporting? If not, why? 10.1 We are not convinced that introducing another category, fair value through OCI is an improvement to financial reporting. It would be preferable for the IASB to complete the financial statement presentation project and articulate the purpose of OCI and the types of gains and losses that are appropriate to be presented in that statement. The idea of fair valuing equity securities though OCI, including dividends with no recycling potentially preempts decisions on financial statement presentation in areas outside the scope of financial instruments such as pension accounting. It may be preferable to delay creating such a new category before the project on financial statement presentation is further advanced. In the very short term, it may be preferable to retain the Available-for-sale category for equity securities and directly address the issues with impairment, for example, to permit reversal of losses through profit or loss and adopting an impairment approach based on the lower of cost and fair value, rather than trying to progress this new category in the time available. Question 11 Do you agree that an entity should be permitted to present in other comprehensive income changes in the fair value (and dividends) of any investment in equity instruments (other than those that are held for trading), only if it elects to do so at initial recognition? If not, (a) (b) how do you propose to identify those investments for which presentation in other comprehensive income is appropriate? Why? should entities present changes in fair value in other comprehensive income only in the periods in which the investments in equity instruments meet the proposed identification principle in (a)? Why? 11.1 As set out in the answer to question 10 above, we are not convinced by the merits of introducing another category. Since it is proposed that dividends and gains and losses on disposal will not be included in the income statement, we believe that it is unlikely that the category would be widely used and need not be introduced in the short-term. This question can best be answered within the context of the project on financial statement presentation and a clear understanding of performance reporting and the purpose of net income as opposed to OCI. Question 12 Do you agree with the additional disclosure requirements proposed for entities that apply the proposed IFRS before its mandated effective date? If not, what would you propose instead and why? 12.1 No. We support an approach to transition based on the IFRS 1 requirements for entities that first adopted IAS 39. In all cases, and not just on early adoption, there should be reconciliation between the closing balance sheet using the existing IAS 39 and the opening, restated balance sheet with explanations for the main changes in classification and measurement.

15 Question 13 Do you agree with applying the proposals retrospectively and the related proposed transition guidance? If not, why? What transition guidance would you propose instead and why? 13.1 We consider that, as drafted, the transitional provisions are impracticable. We have identified the following difficulties. The date of initial application is not clear. While the requirements for hedge accounting in comparative periods are clear, they could result in comparatives that are not meaningful since continuing hedge accounting would be based on classifications and measurements that are now no longer applicable. The proposed simplification for the accounting treatment of hybrid instruments classified as fair value (previously amortised cost) is complex The effort involved in restating up to five comparative periods for entities with US listings will be considerable and cannot meet a reasonable cost/benefit test Therefore, we support an approach to transition based on the IFRS 1 requirements for entities that first adopted IAS 39. In all cases, and not just on early adoption, there should be a reconciliation between the closing balance sheet using the existing IAS 39 and the opening, restated balance sheet with explanations for the main changes in classification and measurement. In our view, this reconciliation would provide more useful and understandable information than restated comparatives If financial liabilities are included in the financial reporting standard applicable for 2009 year ends, it may be appropriate to allow bifurcation to continue for embedded derivatives that exist on the date of transition, particularly for liabilities such as issued long-term debt securities, where the derivative is currently separated and accounted for at fair value through profit or loss and the host contract is carried at amortised cost. It may be appropriate to grandfather such contracts. The embedded derivatives would continue to be carried at fair value and the host contracts at amortised cost, assuming they contain basic loan features. Future contracts entered into will be accounted for under the new standard but this would give entities the opportunity to change the types of arrangements in order to remove the embedded derivatives or otherwise change their financing strategies. Question 14 Do you believe that this alternative approach provides more decision-useful information than measuring those financial assets at amortised cost, specifically: (a) (b) in the statement of financial position? in the statement of comprehensive income? If so, why? 14.1 No. Fair value disclosures are already required by IFRS 7 hence we do not agree with the requirement to include fair values in the statement of financial position provides more decision-useful information. Recognising fair values in the statement of financial position where the financial instruments are not held for trading or otherwise managed on a fair

16 value basis results in less meaningful income statement information and additional complexity in dealing with items in the statement of comprehensive income. With no recycling between OCI and profit or loss, there will be no gains or losses recognised in income on derecognition. In the absence of a rationale for some gains and losses being included in profit or loss and others in OCI, it is difficult to see how this added complexity will result in better financial reporting. Question 15 Do you believe that either of the possible variants of the alternative approach provides more decision-useful information than the alternative approach and the approach proposed in the exposure draft? If so, which variant and why? 15.1 It is difficult to envisage a variant of the alternative approach that would be consistent with the aim of reducing complexity as well as providing more decision-useful information. In our view, requiring fair values to be included in the statement of financial position for financial instruments that are not held for trading or otherwise managed on a fair value basis will always result in additional complexity and will not provide additional information to that already provided by the fair value disclosures already made We do not support the broad direction of the FASB s approach, which is not a mixed measurement model. In our view, where amortised cost provides more useful information, amortised cost should be used in both profit or loss and in the statement of financial position. Measuring items at fair value in the statement of financial position but at amortised cost in profit or loss with the difference included in OCI is not only complex but may provide less useful information in the statement of financial position where amortised cost is the more relevant measure. We agree that some users are interested in the fair values of all financial instruments but believe that this information is appropriately provided in the notes to the financial statements. We would not support including fair value information on the face of the statement of financial position where it is not the most relevant measure. E nigel.sleigh-johnson@icaew.com The Institute of Chartered Accountants in England and Wales 2009 All rights reserved. This document may be reproduced without specific permission, in whole or part, free of charge and in any format or medium, subject to the conditions that: it is reproduced accurately and not used in a misleading context; the source of the extract or document, and the copyright of The Institute of Chartered Accountants in England and Wales, is acknowledged; and the title of the document and the reference number (ICAEWRep100/09) are quoted. Where third-party copyright material has been identified application for permission must be made to the copyright holder.