European Association of Co-operative Banks Groupement Européen des Banques Coopératives Europäische Vereinigung der Genossenschaftsbanken International Accounting Standards Board Brussels, 28 March 2013 30 Cannon Street VH/HS/B16/ London EC4M 6XH United Kingdom Sent electronically to www.iasb.org RE: IASB Exposure Draft: Classification and Measurement Limited Amendments to IFRS 9 Dear Madam, dear Sir, The European Association of Co-operative Banks (EACB) welcomes the opportunity to comment on the Exposure Draft: Classification and Measurement Limited Amendments to IFRS 9 (ED/2012/4) published by the International Accounting Standards Board in November 2012. We highly appreciate this process of gathering views on the topic. Please find our remarks to the ED questionnaire on the following pages. We will remain at your disposal, Yours sincerely, Hervé Guider General Manager Volker Heegemann Head of Legal Department The voice of 4.200 local and retail banks, 50 million members, 160 million customers EACB AISBL Secretariat Rue de l Industrie 26-38 B-1040 Brussels Tel: (+32 2) 230 11 24 Fax (+32 2) 230 06 49 Enterprise 0896.081.149 lobbying register 4172526951-19 www.eurocoopbanks.coop e-mail : secretariat@eurocoopbanks.coop
Contact: Mr. Volker Heegemann, Head of Legal Department (v.heegemann@eurocoopbanks.coop) Intro Mr. Hugo Salvaire, Adviser Banking Supervision (h.salvaire@eurocoopbanks.coop) The European Association of Co-operative Banks (EACB) is the voice of Co-operative Banks in Europe. It represents, promotes and defends the common interests of its 28 members and cooperative banks in general. Co-operative banks form decentralised networks which are governed by banking as well as cooperative legislation. The co-operative banks business model is based on three pillars: democracy, transparency and proximity. Through those pillars co-operative banks act as the driving force of sustainable and responsible development by placing the individual at the heart of their activities and organization. In this respect they widely contribute to the national and European economic and social objectives laid down in the Lisbon Agenda. With 72.000 outlets and 4.000 banks, co-operative banks are widely represented throughout the enlarged European Union playing a major role in the financial and economic system. In other words, in Europe one out of two banks is a co-operative. Co-operative banks have a long tradition in serving 217 million customers, mainly consumers, retailers and SMEs. They have also developed a strong foothold in the corporate market providing services to large international groups. Quantitatively co-operative banks in Europe represent about 56 millions members, 860,000 employees with a total average market share of about 20%. For further details, please visit www.eurocoopbanks.coop 2
General Comments EACB welcomes the decision to make limited amendments to the IFRS 9 Financial Instruments Classification and Measurement model. However, we have some concerns regarding the proposals. Our main messages are the following: - We support the principle-based character of IFRS 9. - IFRS 9 should allow the adequate reflection of the banks business models and consider that the banking business is managed on the basis of portfolios. - The benchmark test is difficult to operationalize and should not be compulsory in any circumstance and especially when an actual benchmark instrument does not exist - In some cases, measurement at amortized cost would provide more useful information than measurement at fair value although the contractual cash flow characteristics assessment is not passed. This applies in particular to regulated financial assets, such as the so-called Livret A -deposits in France, and true banking book financial assets with an interest mismatch feature. - It is important that the introduction of the third category does not change the underlying principle in IFRS 9 and/or does not restrict the use of amortized cost in the measurement of financial assets.. - The proposed effective date of 1 January 2015 is considered unrealistic. The details are set out below in our answers to the questions raised in the ED. Some Members of the EACB reckon that there are still certain financial assets that do not pass the contractual cash flow characteristics assessment. We would like to have some clarifications on the contractual cash flow characteristics assessment. The Members of the EACB also would like to be sure that introducing FVOCI category will not restrict the use of amortized cost measurement category. Furthermore, we regret the exposure draft doesn t take into account some requirements made by the G20, notably regarding liquidity and investor s holding horizon, specifically after 2008 crisis where variations of illiquid instruments had huge effects on the level of P&L of international banks. We think that the notion of illiquidity should be taken into account while classifying financial instruments. Therefore, we believe that it would be better not to measure illiquid assets at fair value through P&L. Please find below our responses to the ED Questionnaire. 3
EACB responses to the ED questionnaire Contractual cash flow characteristics assessment Question 1 Do you agree that a financial asset with a modified economic relationship between principal and consideration for the time value of money and the credit risk could be considered, for the purposes of IFRS 9, to contain cash flows that are solely payments of principal and interest? Do you agree that this should be the case if, and only if, the contractual cash flows could not be more than insignificantly different from the benchmark cash flows? If not, why and what would you propose instead? The EACB supports the clarifications made in the contractual cash flow characteristics assessment by providing guidance when instruments with modified economic relationships contain cash flows that are solely payments of principal and interest. However, we have some concerns regarding the proposed guidance: it does not cover all situations where we believe instruments should be eligible for amortized cost treatment (subject to meeting the business model test), it is difficult to operationalize and burdensome, and it will potentially lead to divergence in practice. EACB welcome the Board s objective to address financial assets with a modified economic relationship (MER), but where amortized cost still provides more useful information. Nevertheless, while we understand the Board s approach to cater for such situations - i.e. still only allows amortized cost accounting when the contractual cash flows characteristics meet the objective of that measurement attribute - we doubt that the proposed benchmark instrument test is the best way to solve the issue of MER in all cases in which amortized cost criterion provides more useful information. In many countries, interest rate-setting mechanisms are different from what it is considered by the Board as normal pricing mechanisms. In particular, this includes the cases of regulated financial assets that are closely linked to financial liabilities and tenor-mismatched financial assets. In such situations, if read in a restricted manner the expression more than insignificant may lead many financial instruments that are effectively managed on long term basis to be classified in the portfolio measured at FVTPL, just because they have characteristics that deviate to some extent from a pure plain vanilla financial instrument. We wonder whether in such circumstances a fair value measurement provides users with more useful information. 4
Moreover, EACB believes that the SPPI test would not be a straightforward exercise and would impact significantly on the bank information systems (the benchmark instrument must be replicated in the systems and documented). This would be especially true when an actual benchmark instrument does not exist and entities might incur significant operational costs to construct hypothetical financial assets as a basis for the assessment. Therefore, EACB believes that the implementation of the more than insignificantly different criterion might require disproportionate efforts for preparers. Furthermore, in many cases where a MER might lead the instrument to fail the sole payments of principal and interest (SPPI) test, especially with regard to retail loans, it is not operationally feasible to determine a reliable fair value even though the assets originated from the bank. In order to resolve the two above issues a scope exception could be introduced (see our remarks in question 3). We think that the approach should be simplified while more flexible. In this regard a reference to market practice combined with the use of reasonable threshold could be a more practical solution. The immateriality of the MER feature could be demonstrated by using qualitative data such as historical analysis. This analysis should compare, over the last years, instruments with MER feature and standard instruments (benchmarks) and conclude, based on historic figures, if cash-flows of instruments with MER feature and cash-flows of benchmarks are significantly different. For example, the analysis can compare financial assets with a floating interest rate which is reset monthly to a threemonth interest rate to instruments with an interest rate is reset to a monthly interest rate and see if the cash-flows are different over the last years. If they are not different, for a certain length of time and different scenarios, the entity can conclude that the MER feature is immaterial Therefore, remaining on a pure principle based approach, it could be opportune to use a different wording (e.g. not significant ) and improve the guidance drawn in the ED. In addition we feel, that the wording of the ED is not clear enough on whether or not the MER test has to be made under all circumstances or if an entity may choose not to undertake the test with the consequence that the financial instrument is measured at fair value with fair value changes through profit or loss. In our opinion voluntary testing would allow for cost-benefit-considerations in each case and therefore meet the needs of preparers without creating room for abuse. We therefore advocate for substituting shall by can in B4.1.9B of the ED. We also wonder if there is any indication that the current threshold in IAS 39 (double/double test) has proven to be too low and hence justifying accounting entirely for instruments from which embedded derivatives are not separated under IAS 39 at fair value through profit and loss (FVTPL). This point is relevant in order to ascertain the consistency and appropriateness of the threshold set by the Board for the SPPI test ( insignificantly different ). Finally, we have some concerns that the threshold could vary for the same instrument from holder to holder or simply because it is analyzed from the perspective of the issuer or the holder. 5
Question 2 Do you believe that this Exposure Draft proposes sufficient, operational application guidance on assessing a modified economic relationship? If not, why? What additional guidance would you propose and why? In our view the application guidance should remain principle based. Specific additional guidance is not requested. Moreover we would like to consider the examples set in the application guidance as a mere examples and not as a constrains. *** 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? We expect that the proposed amendment will result in some instruments with very minor interest rate mismatch features, which would not have met the original assessment, qualifying for amortized cost measurement. However we refer to our comments in questions 1 and 2 with regard to implementing the proposed guidance. We think the proposed guidance does not identify appropriately the relevant set of instruments that have solely payments of principal and interest on the principal amount outstanding. We ask the IASB to carefully consider the situations and instruments below before finalizing the standard and specifically assess whether in those cases FVTPL or amortized cost would be more useful for users of financial statements. Regulated financial assets that are closely linked to financial liabilities- Some of our Members have specific financial instruments where the financial institutions act as intermediaries collecting deposits from customers and handing them over to a public institution which is in charge of using these funds in order to finance particular activities of general interest. These financial instruments are not structured instruments and are clearly held to collect cash flows. The loans 6
to the government yield the same interest rate as the deposits received from customers, which are regulated by the government. Depending on the formula used, the interest rate might not only reflect market interest rates and variables (e.g. Eonia, Euribor, and inflation) but also include specific spreads, caps and floors imposed by the specific regulation. Furthermore, the government might have discretion to modify the rate obtained from applying the formula. As mentioned in the IASB staff paper Agenda paper 6B 15 October 2012 Sweep issue regulated interest rates, we think the Board should provide for a narrow scope exception for instruments with state-regulated loans, whenever these instruments are held in order to collect their cash flows (held to collect business model). However, the scope exception should not be limited to regulated jurisdictions, as it seems to be recommended in paragraph 14 of the staff paper. We would welcome an exemption related to specific regulated submarkets coexisting with broader market based on financial market interest rates. In these sub-markets the regulated loan is itself a benchmark and the related rate is observable by all parties as the government discloses it whenever it is changing. Tenor-mismatched financial assets In some countries, in order to meet the customer needs or due to asset and liability management purposes or other operational reasons, it is common operational/market practice to originate certain type of financial assets, in most cases loans, in which the economic relationships between principal and the consideration for the time value of money and the credit risk may be modified by an interest rate reset feature. We think that the SPPI test, as defined by IASB, is highly abstract because do not recognize how banks actually manage and price their financial instruments. Furthermore it is overly complex especially when it requires the use of a theoretical benchmark. In order to avoid that true banking book financial assets will be classified in the FVTPL portfolio, the IASB should consider to introduce a scope exception (by requiring to perform only the business model test), setting aside cases in which a leverage is created. Finally, a more simplified, flexible and practical solution could be defined by making a reference to market practice and requiring the use of reasonable threshold. Therefore, remaining on a pure principle based approach, it could be opportune to use a different wording (e.g. not significant ) and improve the guidance drawn in the ED. Financial assets with early automatic redemption features We believe that the current guidance in IFRS 9 should clarify that a financial asset with an automatic early (partial) redemption feature linked to credit risk deterioration of the issuer and that prepays principal and accrued interest should not be excluded from measurement at amortized cost. For example, such contractual terms might be included in debt instruments issued by companies operating in the infrastructure sector and usually require an automatic early (partial) redemption of the principal if certain credit risk related performance milestones are not achieved. In our view, the accounting effects of prepayment options and automatic redemption features linked to the credit risk of the issuer are identical if not the same. However, the current guidance in paragraph B.4.1.12 regarding contractual terms that change the timing or amount of the payments of principal 7
and interest only allows certain types of prepayment or extension options to be eligible for a measurement category other than FVTPL. EACB notes that many Members have not completed their impact analysis of IFRS 9 yet; therefore we may not exclude that more financial instruments may exist for which the contractual cash flow characteristics assessment might not pass, despite the fact that amortized cost measurement provides more useful information. In this respect EACB is one of the partners of EFRAG project to organize a fact finding exercise on how the proposed new requirements would affect the current classification and measurement of financial assets. 8
Business Model Assessment Question 4 Do you agree that financial assets that are held within a business model in which assets are managed both in order to collect contractual cash flows and for sale should be required to be measured at fair value through OCI (subject to the contractual cash flow characteristics assessment) such that: (a) interest revenue, credit impairment and any gain or loss on derecognition are 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? Basically, we support the IASB s proposal to introduce a new category for financial instruments which are both to collect contractual cash flows and to sell. We suggest defining the new category as an overlay with the objective to eliminate or reduce accounting mismatches as this better reflects the dual nature of the business model. The use of the third category should be an option. It is important that the introduction of the third category does not change the underlying principle in IFRS 9 and/or does not restrict the use of amortized cost in the measurement of financial assets. As a general comment, EACB believes that IFRS 9 should be based on a limited number of measurement categories and provide a clear rationale for each of those categories, as this would result in more useful reporting information while making IFRS 9 easier to apply by preparers by avoiding complexity. It is of utmost importance that the introduction of the third business model do not change the underlying principles in IFRS 9 for the amortized cost measurement category (instead of providing clarification) and, as a consequence, restrict the use of the latter criterion in the measurement of financial assets. To this regard paragraph BC30 in the ED indicates that the IASB did not seek to increase or reduce the use of fair value measurement with the introduction of the third business model, rather it sought to ensure that relevant information is provided. Furthermore, the IASB expected that part of the financial assets which would have been measured at FVTPL would fall within the FVTOCI category. However we fear, that significant accounting mismatches will remain as not all financial assets backing insurance liabilities qualify for FVTOCI (for example structured investments, hedging derivatives and investment property). Therefore, FVTOCI category should be expanded to cover more instruments and not just restrict to debt instruments that pass the SPPI test. Entities should be able to measure eligible financial assets at FVTOCI if by doing so eliminate or 9
reduce an accounting mismatch that would otherwise arise from measuring financial assets and the related liabilities on different bases. Additionally it is important to note that in order to avoid accounting mismatches resulting from insurance transactions it may be necessary to designate financial instruments as at FVTOCI which are held under a hold to collect business model and therefore would normally have to be categorized as Amortized Cost. In order to better reflect the accounting mismatches resulting from Amortized Cost financial instruments backing insurance liabilities we therefore ask the IASB to consider if defining the category FVTOCI as an option could solve the insurance sector issue. Otherwise, the IASB should further investigate this issue, adequately adopting the definition of business model that should be more closely linked to asset-liability management strategies. This should remove concerns raised by the insurance industry regarding the potential accounting mismatch that might arise in profit or loss due to the interaction between the accounting for financial assets under IFRS 9 and the accounting for insurance liabilities under the future insurance contracts standards. We would welcome the opening of the FVTOCI also to assets which are part to the Basel 3 liquidity reserves (assets of Level 2b which include common equity corporate shares, constituent of major stock index), as long as they are compliant with the only FVTOCI business model. That said, we agree with the accounting treatment of fair value through OCI (FVTOCI) category. We suggest defining this new category as residual and use the trading definition as a defined bucket. This would better reflects the dual nature of the business model, i.e. neither fully FVTPL (not trading) nor fully held to collect, and hence siting in between the two. *** 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? In our view the application guidance should remain principle based. Specific guidance cannot be provided for every imaginable case. However, it should be made clear that when an entity holds financial assets to meet its liquidity needs in a stress case scenario (and does not anticipate selling significant volumes of these assets except in such scenarios) and, at the same time, it is required by prudential regulation to periodically sell a portion of those financial assets to demonstrate that the assets are liquid ( liquidity testing ), etc. the objective of the entity s business model is not inconsistent with holding financial assets to collect contractual cash flows, except for that portion to be liquidated periodically via outright sales that should be classify in FVTOCI 10
category. In the case in which it is common practice by the bank to perform the liquid testing via repurchase agreements operation instead of outright sales then the liquid assets should be allowed to be classified in the amortized cost category, provided that the SPPI and business model test are met with. The only justified reason for selling financial assets within amortized cost category without looking at frequency and volume or remaining maturity is the credit deterioration. EACB believe that exceptional situation should be also take into account such as circumstances that are attributable to isolated events that are beyond the entity s control, are non-recurring and could not have been reasonably anticipated by the entity. 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? We strongly advocate for the third category being an option (please see our answer to Q4). If the third category becomes mandatory, we agree that the existing fair value option in IFRS 9 should be extended to financial assets that would otherwise be mandatorily measured at FVTOCI if this eliminates or significantly reduces an accounting mismatch. 11
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 proposed transition. Concerning the early application requirements, some Members are in favour of partial endorsement-steps with a split between the Macro Hedging s project and the IFRS 9 s project, while others rather support an application on a whole basis including macro-hedging. This being said, all members consider the date of implementation, 01.01.2015, unrealistic. Indeed, we think it will take at least 2 years to implement the new standard since the text has been published. Members that are part of a financial conglomerate are concerned about differing implementation dates for IFRS 9 and IFRS 4, especially with regard to partial endorsement. They believe that in this case special facilities need to be found. 12
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? We agree with the option to apply early only the own credit provisions in IFRS 9 once the completed version of IFRS 9 is issued since we believe that the accounting treatment for changes in own credit risk for financial liabilities designated at FVTPL provides better information for users of financial statements and is sufficiently narrow that the risk of unintended consequences is low. Furthermore, EACB reiterates its position to amend IAS 39 to align it to the requirement in IFRS 9 regarding the accounting for own credit risk on financial liabilities measured at fair value. 13
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? 14
Other Issues Beyond the aspects addressed in the questions, we would like to draw the Board s attention to the following: We believe that the criteria for reclassification are too restrictive compared to IAS 39. Reclassifications should also be allowed in those rare circumstances (as it was possible in IAS 39), in which a reliable measurement of the fair value of financial assets is no longer available, even if such reclassifications do not pass the SPPI test. We also believe that general hedge accounting rules may be too difficult to apply to interest rate hedging of insurance liabilities. It may be useful to develop the macro hedging project to cover also effective hedges of insurance liabilities and the related financial assets. This approach could remove accounting mismatch of insurance liabilities and assets backing those liabilities. Regarding bifurcation of assets issue, we think it would be better to allow bifurcation for financial assets as it was agreed in IAS39. Indeed, we believe that some of the hosts contracts should be measured at amortized cost as they are held for cash-flow purpose and that it doesn t increase dramatically the complexity of the accounting treatment as it is already done for IAS39 and it will necessarily be done for liabilities. 15