Reconciling IFRS with Regulatory Filings A former CFO s Experience

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Kristian Bryan
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International Financial Reporting Standards Reconciling with Filings A former CFO s Experience Executive workshop for Regulators Diplomatic Academy of Vienna Darrel Scott, IASB member

1 International Financial Reporting Standards Reconciling with Filings A former CFO s Experience Executive workshop for Regulators Diplomatic Academy of Vienna Darrel Scott, IASB member The views expressed in this presentation are those of the presenter, not necessarily those of the IASB or Foundation Foundation. 30 Cannon Street London EC4M 6XH UK.

2 Introduction 2 is a useful starting point for regulatory governance BUT Only if differences are clearly understood, and adjusted for Regulators have a number of tools to adjust results: Recognition/derecognition of assets/liabilities Adjustments to capital balances Risk weightings Ring fencing of capital balances 2 Foundation 30 Cannon Street London EC4M 6XH UK.

3 Objective 3 Objective of financial reporting is to provide information for effective resource allocation. Focus therefore on: Effects of market events Volatility of results Transparency Efficient capital utilisation 3 Foundation 30 Cannon Street London EC4M 6XH UK.

4 Objective continued 4 view is about stability of sector. Focus therefore: Stability of earnings and balance sheet Controlled release of information Reserving in good times Conservative capital policies 4 Foundation 30 Cannon Street London EC4M 6XH UK.

5 Differences in approach 5 Point in time reflection of current economics Neutral Asset/liability focus Transaction focused across all industries and jurisdictions Generally principle based Wide variety of constituents slows down turnaround Forward looking focus anticipating economics Prudent Equity (Capital focus) Industry and jurisdiction focused Generally rules based Rapid turnaround 5 Foundation 30 Cannon Street London EC4M 6XH UK.

6 Communication 6 Regulators Effect of differences Impact on ratios Impact on regulatory action Analysts Understanding capital vs equity Ration analysis Availability of reserves Education 6 Foundation 30 Cannon Street London EC4M 6XH UK.

7 Assets 7 Similar starting points for both and regulatory views Resource controlled as a result of past events and from which future economic benefits are expected to flow Mixed valuation model (Fair value vs Amortised cost) Neutrality Economic point in time Primary distinctions Unexpected losses Liquidity portfolios Recognition 7 Foundation 30 Cannon Street London EC4M 6XH UK.

8 Liabilities 8 Similar starting points for both and regulatory views Present obligation from past events, settlement of which is expected to result in outflow of resources Mixed valuation model (Fair value vs Amortised cost) Neutrality Economic point in time Primary distinctions Convertible debt Recognition Own credit 8 Foundation 30 Cannon Street London EC4M 6XH UK.

9 Assets and liabilities 9 Similar starting points for both and regulatory views Assets and liabilities required to be presented gross on the balance sheet, unless certain specific criteria are met Assets and liabilities presented on balance sheet if probably. Possible (or contingent) assets and liabilities may still require disclosure, but not necessarily on balance sheet Primary distinctions Offsetting Probability criteria 9 Foundation 30 Cannon Street London EC4M 6XH UK.

10 Comprehensive income 10 Similar starting points for both and regulatory views Change in economic benefits during period from changes of assets (liabilities) Mixed valuation model (Fair value vs Amortised cost) Dependence on asset/liability measurements 10 Foundation 30 Cannon Street London EC4M 6XH UK.

11 Equity 11 Similar starting points for both and regulatory views Residual interest in the assets of an entity after deducting its liabilities Different focal points point in time driven, regulatory tends to be event driven Primary distinctions Convertible debt Unrealised gains Equityholder transactions 11 Foundation 30 Cannon Street London EC4M 6XH UK.

12 Other 12 A number of other factors are relevant to understanding the relationship between and prudential regulation Primarily relate to disclosure issues, and distinctions in viewpoints Not necessarily relevant from reconciliation perspective, but relevant to the objectives Primary issues Perspective Narrative reporting Risk Reporting 12 Foundation 30 Cannon Street London EC4M 6XH UK.

13 Other Perspective 13 Financial reporting perspective shareholder/credit provider Outsider looking in with limited access to additional information Information not confidential so commercial sensitivity relevant Looked at from access point (eg listed holding company for shareholder, or ultimate guarantor for credit provider) reporting viewed from perspective of regulated entity Regulator usually has ability to access additional information 13 Is Foundation usually 30 Cannon Street London confidential EC4M 6XH UK.

14 Summary 5 Regulators and other users do have different objectives But, difference are only on the margin Regulators and standard setters should seek to reduce differences as much as possible Regulators, preparers and other users should seek to understand those differences and their consequences Two sets of financials are bad, disclosure is better Disclosure (regulator or IASB driven) should address: Differences, and adjustments made Restrictions in information Remedies? 14 Foundation 30 Cannon Street London EC4M 6XH UK.

15 Thank You 15 Foundation. 30 Cannon Street London EC4M 6XH UK.

16 Assets Unexpected losses Based on concept of neutrality Amortised cost assets impaired for incurred or expected losses Impairments based on unbiased expected future cash flows Usually requires a trigger event 16 Prudential requirements drive conservative outlook Amortised costs assets impaired for both expected and unexpected losses Impairments based on downturn or stressed expected future cash flows Unexpected impairments require no trigger event 16 Foundation 30 Cannon Street London EC4M 6XH UK.

17 Assets Unexpected losses continued 17 Fair value assets carried at market value at year end date Market values generally incorporate a risk premium to reflect unexpected losses Reporters generally not permitted to adjust market values Prudential requirements drive conservative outlook Some regulators require haircuts for certain fair value assets (eg unlisted shares) Alternatively, may increase risk weighting 17 Foundation 30 Cannon Street London EC4M 6XH UK.

18 Assets Liquidity portfolios 18 Business model test ( 9) Business model for liquidity portfolio is often hold to collect, therefore amortised cost Prudential turnover requirements may corrupt business model Prudential requirements anticipate realisation of liquidity portfolios Fair value may be more appropriate indicator of future realisations 18 Foundation 30 Cannon Street London EC4M 6XH UK.

19 Assets Recognition/derecognition 19 Based on risk/reward and control tests Ignores legal form other then as impact on the above Cost or value that can be measured reliably Recognition/derecognition of an asset results in recognition/derecognition of corresponding liability (repos) Generally based on legal form of transaction May result in fewer assets being recognised on a regulatory balance sheet May result in different profit/loss recognition timing 19 Foundation 30 Cannon Street London EC4M 6XH UK.

20 Assets Deferred tax asset Deferred tax asset recognised under certain circumstances Dependent upon unbiased expected future utilisation of asset 20 Prudential requirements generally don t recognise deferred tax assets (prudent approach) Impact either through capital haircut, capital risk weighting or derecognition 20 Foundation 30 Cannon Street London EC4M 6XH UK.

21 Liabilities Convertible debt Characterised into two components (liability/equity) based on Day 1 economics Carrying value based on day 1 values, equity not updated over life of contract No changes in classification after initial classification Characterised into to components based on contractual outcome 21 Carrying value based on day 1 value and contractual outcome Haircut classification changes over time Tier II 21 Foundation 30 Cannon Street London EC4M 6XH UK.

22 Liabilities Convertible debt example 22 Bank A issues a $100 convertible bond at a coupon of 5% per year, repayable in full after 25 years. The bond is fully convertible into ordinary shares at the option of the issuer anytime during the 25 year period. The equivalent rate of debt issued without the convertible option is 4.75% considerations: Issued as debt, most likely outcome is debt, reported as mostly debt (liability 103.6, capital -3.6) Prudential considerations: Convertibility at option of issuer probably makes this available capital, likely to be viewed as capital, with some form of haircut as maturity approaches 22 Foundation 30 Cannon Street London EC4M 6XH UK.

23 Liabilities Recognition/derecognition 23 Based on a probable threshold Frequently driven by asset recognition criteria Generally based on legal form of transaction Impact on liabilities will reflect the impact on assets 23 Foundation 30 Cannon Street London EC4M 6XH UK.

24 Liabilities Own Credit 24 Introduction Fair value of financial instruments includes pricing for the credit risk inherent in the instrument (credit premium) Liabilities carried at fair value incorporate this credit margin (own credit) Changes in own credit behave counter-intuitively decline in entities credit standing results in a profit, improvement in entities credit standing results in a loss) 24 Foundation 30 Cannon Street London EC4M 6XH UK.

25 Liabilities Own Credit For fair value liabilities, adjustments to own credit: Reflect immediately in profit and loss (under IAS 39) Will be reflected in OCI in certain circumstances under 9 Always in capital Is not reflected in carrying value of amortised cost liabilities 25 Practices differ considerably Usually any gain is not allowed to form part of capital 25 Foundation 30 Cannon Street London EC4M 6XH UK.

26 Assets and liabilities Offsetting Required to offset under certain circumstances A currently enforceable legal right of set-off, and Intention either to settle net basis or to realise the financial asset and settle the financial liability simultaneously Focus on expected cash flows and current enforceability 26 Allowed to offset under certain circumstances An enforceable legal right of set-off, and Ability to settle net basis or to realise the financial asset and settle the financial liability simultaneously Focus on credit risk in default scenario 26 Foundation 30 Cannon Street London EC4M 6XH UK.

27 Assets and liabilities Off balance sheet Principle based Probable threshold Risk/reward and control tests Disclosure of underlying position, but not on-balance sheet: Loan commitments Guarantees Acceptances Repos 27 Foundation 30 Cannon Street London EC4M 6XH UK. Rules based 27 Jurisdiction/industry specific May treat some/many/most differently to under specific approaches

28 Assets and liabilities Consolidation Principle based Substance over form Full consolidation (other then for joint operations) Associates and joint ventures remain off balance sheet No NCI haircut 28 Only relevant to consolidated supervision May be rules based (Legal form) Often requires proportionate consolidation for some subsidiaries, associates and joint ventures NCI Haircut 28 Foundation 30 Cannon Street London EC4M 6XH UK.

29 Assets and liabilities Hedging Hedge accounting permitted under specific circumstances Rules based under IAS 39, and sometimes does not risk management practices 9 more risk based Has the effect of changing valuation basis (greater degree of fair value accounting) 29 Generally only considered as part of risk management returns Not sure of the extent of understanding or analysis Forms greater part of risk analysis 29 Foundation 30 Cannon Street London EC4M 6XH UK.

30 Comprehensive income Interest recognition 30 Interest/discount unwind recognised on impaired balances Based on expected amount rather then contractual amount Interest my be recognised based on contractual terms Subject to a separate interest in suspense adjustment Bookkeeping versus presentation 30 Foundation 30 Cannon Street London EC4M 6XH UK.

31 Comprehensive income Equity/liability classifications 31 Where balance sheet classification is liability Income/expense, gain/loss shown in income statement Where classification is equity, shown directly in equity Different classifications of debt equity will result in different treatment in the income statement 31 Foundation 30 Cannon Street London EC4M 6XH UK.

32 Comprehensive income Asset/Liability measurement and recognition 32 Differences Differences in asset liability measurement will affect comprehensive income Examples include: Recognition of impairments Unexpected losses Differences in recognition/derecognition criteria will affect comprehensive income Examples include: Securitised assets Repurchase agreements 32 Foundation 30 Cannon Street London EC4M 6XH UK.

33 Equity Unrealised Gains and losses 33 Fair value assets and liabilities (FVPL, FVOPL, FVOCI) Unrealised gains and losses treated symmetrically Credited/debited (net of tax effect) to equity Potentially broader (focus may be on all assets and liabilities) Frequently not symmetrical losses accelerated relative to gains Haircut often applied to FVOCI gains, although interestingly often not to FVPL and FVOPL 33 Foundation 30 Cannon Street London EC4M 6XH UK.

34 Equity Equityholder transactions 34 Defined equityholder transactions do not go through comprehensive income Future equityholder transactions, even if contractual, are not recorded in the primary statement Different definitions of equity may give rise to different Income treatment Future equityholder transactions eg guaranteed capital injections or conversions may be treated as capital 34 Foundation 30 Cannon Street London EC4M 6XH UK.

35 Equity Reserves Single definition of equity Measurement of equity dependent on measurement of assets and liabilities Restrictions on asset liability measurement (eg neutrality) impacts on equity measurement (unexpected losses) 35 Capital may be sub-divided with many sub definitions (tier I, tier II, distributable, non distributable) Different asset liability requirements may result in different residual capital amounts eg unexpected loss provisions 35 Foundation 30 Cannon Street London EC4M 6XH UK.

36 Equity Non controlling interest Capital contributed by shareholders in defined subsidiaries Consolidation entry Included in equity at proportionate share of underlying assets owned by outside shareholders Generally not haircut Dependent on extent of consolidated capital supervision 36 Dependent upon consolidation rules Generally split between capital of regulated and non regulated entities Usually haircut to prevent cross-subsidisation 36 Foundation 30 Cannon Street London EC4M 6XH UK.

37 Equity Intangible assets Intangible assets recognised under certain circumstances This has an impact on equity balances (residual) 37 Generally prudential regulators don t recognise value of intangible assets Impact either through capital haircut, capital risk weighting or derecognition 37 Foundation 30 Cannon Street London EC4M 6XH UK.

38 Equity Cumulative other comprehensive income 38 Accumulated from a number of different asset/liability sources Primary classes Cash flow hedges Own credit Pension Liabilities Some recycled, some not Balance is accumulated to equity Different OCI balances viewed with different merit by prudential regulators Distinguish between realised/unrealised Profit/loss 38 Foundation 30 Cannon Street London EC4M 6XH UK.

39 Equity Residual effect 39 Differences Differences in asset liability measurement will affect equity Examples include: Recognition of impairments Unexpected losses Differences in equity/liability classification will effect equity Examples include Convertible debt Equity derivatives Difference in income treatment will affect equity 39 Foundation 30 Cannon Street London EC4M 6XH UK.

40 Other Risk reporting Extensive narrative and quantitative financial reporting required Includes sensitivity analysis, maturity analysis, risk management techniques, policies, breaches and governance Focussed at reporting entity level (group), and reconciles to those numbers Confidential reporting May be tailored to entity 40 Focussed on regulated entity Can create confusion/duplication because of difference in entity/specifics Can be tailored for market events 40 Foundation 30 Cannon Street London EC4M 6XH UK.

41 Other Post balance sheet events 41 Specific requirements for postbalance sheet events Where circumstances existed at yearend, and entity became aware of them post yearend, adjustment to results required Where circumstances did not exist at yearend, disclosure only Regulators generally prefer adjustment for all known events, even if circumstances only occurred post year end. 41 Foundation 30 Cannon Street London EC4M 6XH UK.

Accounting for Financial Instruments

International Financial Reporting Standards Accounting for Financial Instruments (IAS 39) Executive IFRS workshop for Regulators Diplomatic Academy of Vienna Darrel Scott, IASB member The views expressed